Business Marketing Management: B2B This page intentionally left blank Business Marketing Management: B2B 10 e MICHAEL D. HUTT Arizona State University • THOMAS W. SPEH Miami University Australia • Brazil • Japan • Korea • Mexico • Singapore • Spain • United Kingdom • United States Business Marketing Management: B2B, Tenth Edition Michael D. Hutt and Thomas W. Speh Vice President of Editorial, Business: Jack W. Calhoun Editor-in-Chief: Melissa Acuna Acquisitions Editor: Mike Roche Developmental Editor: Erin Berger Editorial Assistant: Shanna Shelton Senior Marketing Coordinator: Sarah Rose Executive Marketing Manager: Kimberly Kanakes © 2010, 2007 South-Western, Cengage Learning ALL RIGHTS RESERVED. 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For your course and learning solutions, visit www.cengage.com Purchase any of our products at your local college store or at our preferred online store www.ichapters.com Printed in Canada 1 2 3 4 5 6 7 8 12 11 10 09 To Rita and to Sara, and in memory of Michele This page intentionally left blank PREFACE Special challenges and opportunities confront the marketer who intends to serve the needs of organizations rather than households. Business-to-business customers represent a lucrative and complex market worthy of separate analysis. A growing number of collegiate schools of business in the United States, Canada, and Europe have added industrial or business marketing to their curricula. In addition, a large and growing network of scholars in the United States and Europe is actively engaged in research to advance theory and practice in the business marketing field. Both the breadth and quality of this research has increased markedly during the past decade. The rising importance of the field can be demonstrated by several factors. First, because more than half of all business school graduates enter firms that compete in business markets, a comprehensive treatment of business marketing management appears to be particularly appropriate. The business marketing course provides an ideal platform to deepen a student’s knowledge of the competitive realities of the global marketplace, customer relationship management, cross-functional decision-making processes, supply chain management, e-commerce, and related areas. Such core content areas strike a responsive chord with corporate recruiters and squarely address key educational priorities established by the American Assembly of Collegiate Schools of Business (AACSB). Second, the business marketing course provides a perfect vehicle for examining the special features of high-technology markets and for isolating the unique challenges that confront the marketing strategist in this arena. High-tech markets represent a rapidly growing and dynamic sector of the world economy and a fiercely competitive global battleground but often receive only modest attention in the traditional marketing curriculum. Electronic (e) commerce also falls squarely into the domain of the business market. In fact, the opportunity for e-commerce in the business-to-business market is estimated to be several times larger than the opportunity that exists in the business-to-consumer market. Third, the Institute for the Study of Business Markets (ISBM) at Pennsylvania State University has provided important impetus to research in the area. ISBM has become a major information resource for researchers and practitioners and has assumed an active role in stimulating and supporting research on substantive business marketing issues. In turn, the number of research studies centered on the business-to-business domain has significantly expanded in recent years, and specialized journals in the area attract a steady stream of submissions. The hard work, multiyear commitments, and leadership of the editors of these journals are worthy of note: Journal of Business-to-Business Marketing, J. David Lichtenthal, Baruch College; Journal of Business & Industrial Marketing, Wesley J. Johnston, Georgia State University; and Industrial Marketing Management, Peter LaPlaca, University of Connecticut. Three objectives guided the development of this edition: 1. To highlight the similarities between consumer-goods and business-to-business marketing and to explore in depth the points of departure. Particular attention is given to market analysis, organizational buying behavior, customer relationship management, supply chain management, and the ensuing adjustments required in the marketing strategy elements used to reach organizational customers. 2. To present a managerial rather than a descriptive treatment of business marketing. Whereas some descriptive material is required to convey the vii viii Preface dynamic nature of the business marketing environment, the relevance of the material is linked to marketing strategy decision making. 3. To integrate the growing body of literature into a strategic treatment of business marketing. In this text, relevant work is drawn from organizational buying behavior, procurement, organizational behavior, supply chain management, strategic management, and the behavioral sciences, as well as from specialized studies of business marketing strategy components. The book is structured to provide a complete and timely treatment of business marketing while minimizing the degree of overlap with other courses in the marketing curriculum. A basic marketing principles course (or relevant managerial experience) provides the needed background for this text. New to This Edition Although the basic objectives, approach, and style of earlier editions have been maintained, several changes and additions have been made that reflect both the growing body of literature and the emerging trends in business marketing practice. Specifically, the following themes and distinctive features are incorporated into the tenth edition: • Relationship Marketing Strategies: new and expanded coverage of the drivers of relationship marketing effectiveness and the financial impact of relationship marketing programs. • Strategic Alliances: a timely and richly illustrated discussion of the determinants and social ingredients of alliance success. • Strong B2B Brands: specific steps for building and managing a profitable B2B brand. • Marketing Performance Measurement: a timely treatment of specific metrics for measuring the impact of marketing strategy decisions on firm performance. • A Value-Based Approach for Pricing: a timely description of a framework for identifying and measuring value by customer segment. • A Customer-Centered Approach to Channel Design: a fresh approach for designing channels from the bottom up, rather than the top down. • Other new topics of interest: the new edition includes expanded treatment of customer experience management, corporate entrepreneurship, strategic positioning, and the emerging trends in online advertising strategies. Organization of the Tenth Edition The needs and interests of the reader provided the focus in the development of this volume. The authors’ goal is to present a clear, timely, and engaging examination of business marketing management. To this end, each chapter provides an overview, highlights key concepts, and includes several carefully chosen examples of contemporary business Preface ix marketing practice, as well as a cogent summary and a set of provocative discussion questions. Contemporary business marketing strategies and challenges are illustrated with three types of vignettes: “B2B Top Performers,” “Inside Business Marketing,” and “Ethical Business Marketing.” The book is divided into six parts with a total of 17 chapters. Part I introduces the distinguishing features of the business marketing environment. Careful examination is given to each of the major types of customers, the nature of the procurement function, and key trends that are reshaping buyer-seller relationships. Relationship management establishes the theme of Part II, in which chapter-length attention is given to organizational buying behavior and customer relationship management. By thoroughly updating and illustrating the core content, this section provides a timely and comprehensive treatment of customer profitability analysis and relationship management strategies for business markets. After this important background is established, Part III centers on the techniques that can be applied in assessing market opportunities: market segmentation and demand analysis, including sales forecasting. Part IV centers on the planning process and on designing marketing strategy for business markets. Recent work drawn from the strategic management and strategic marketing areas provides the foundation for this section. This edition provides an expanded and integrated treatment of marketing strategy development using the balanced scorecard, enriched by strategy mapping. Special emphasis is given to defining characteristics of successful business-to-business firms and to the interfacing of marketing with other key functional areas such as manufacturing, research and development, and customer service. This functionally integrated planning perspective serves as a focal point in the analysis of the strategy development process. Here at the core of the volume, a separate chapter provides an integrated treatment of strategy formulation for the global market arena, giving particular attention to the new forms of competitive advantage that rapidly developing economies present (for example, China). Next, each component of the marketing mix is examined from a business marketing perspective. The product chapter gives special attention to the brand-building process and to the strategic importance of providing competitively superior value to customers. Adding further depth to this core section are the chapters on managing product innovation and managing services for business markets. In turn, special attention is given to e-commerce and supply chain strategies for business markets. Building on the treatment of customer relationship marketing provided in Part II, the personal selling chapter explores the drivers of relationship marketing effectiveness as well as the financial impact of relationship marketing programs. Marketing performance measurement provides the central focus for Part V. It provides a compact treatment of marketing control systems and uses the balanced scorecard as an organizing framework for marketing profitability analysis. Special attention is given to identifying the drivers of marketing strategy performance and to the critical area of strategy implementation in the business marketing firm. Part VI includes a collection of cases tailored to the business marketing environment. Cases Part VI includes 12 cases, 8 of which are new to this edition. These cases, of varying lengths, isolate one or more business marketing problems. Included among the selections for this edition are cases that raise provocative issues and illustrate the x Preface challenges and opportunities that small firms confront and the best practices of leadingedge firms such as Medtronics Corporation, Hewlett-Packard, FedEx, and 3M Canada. Other cases new to this edition provide students with a variety of business marketing strategy applications. A Case Planning Guide, which keys the cases to relevant text chapters, provides an organizing structure for Part VI. In addition, a short case, isolating core concepts, is included with each chapter. Two-thirds of the endof-chapter cases are new to this edition and uncover opportunities and challenges confronting firms such as Apple, Intuit, Sealed Air Corp, SunPower, and Cisco. These cases provide a valuable tool for sparking class discussion and bringing strategy issues to life. Ancillary Package We are most indebted to John Eaton, Arizona State University, for his fine work in bringing together all of the elements of the ancillary package so that all supplements work together seamlessly. The ancillary package includes: Instructor’s Resource CD (IRCD) The Instructor’s Resource CD delivers all the traditional instructor support materials in one handy place: a CD. Included on the CD are electronic files for the complete Instructor’s Manual, Test Bank, computerized Test Bank and computerized Test Bank software (ExamView), and chapter-by-chapter PowerPoint presentation files that can be used to enhance in-class lectures. PowerPoint files have been thoroughly updated and feature hundreds of new slides that instructors can use to tailor their lectures to their particular needs and preferences. We are indebted to Ray DeCormier, Central Connecticut State University, for developing the PowerPoint files and for contributing his expertise to this project. Instructor’s Manual The Instructor’s Manual for the tenth edition of Business Marketing Management: B2B provides a variety of creative suggestions designed to help the instructor incorporate all the materials available to create a dynamic learning environment. A few of the key features available in the Instructor’s Manual for this edition include • course design suggestions • chapter outlines and supporting chapter materials • suggested readings listed by chapter • case analysis suggestions as well as assessment rubrics • cooperative learning exercises • ideas for effectively integrating the video package into the classroom discussion The Instructor’s Manual files are located on the IRCD and are also available for download at the text support site, http://www.cengage.com/marketing/hutt. Preface xi Test Bank The revised and updated Test Bank includes over 1,500 multiple-choice and true/false questions, emphasizing the important concepts presented in each chapter, along with an average of five essay questions per chapter. The Test Bank questions vary in levels of difficulty so that each instructor can tailor the testing to meet specific needs. Each question is tagged to AACSB standards, discipline guidelines, and Rubin/Dierdorff standards. The Test Bank files are located on the IRCD. ExamView (Computerized) Test Bank The Test Bank is also available on the IRCD in computerized format (ExamView), allowing instructors to select problems at random by level of difficulty or type, customize or add test questions, and scramble questions to create up to 99 versions of the same test. This software is available in Mac or Windows formats. PowerPoint Presentation Slides The PowerPoint presentation slides bring classroom lectures and discussions to life with the Microsoft PowerPoint presentation tool. These presentations are organized by chapter, helping to create an easy-to-follow lecture, and are extremely professor friendly and easy to read. There are two PowerPoint versions for this edition: the GOLD version includes varying slide background and animation; the SILVER version provides simpler design for professors who would like to add their own material. The PowerPoint presentation slides are available on the IRCD and as downloadable files on the text support site, http://www.cengage .com/marketing/hutt. Web Site Visit the text Web site at http://www.cengage.com/marketing/hutt to find instructor’s support materials as well as study resources that will help students practice and apply the concepts they have learned in class. Videos A new video package has been prepared to provide a relevant and interesting visual teaching tool for the classroom. Each video segment applies text materials to the real world, demonstrating how everyday companies effectively deal with business marketing management issues. Student Resources Online quizzes for each chapter are available on the Web site for those students who would like additional study materials. After each quiz is submitted, automatic feedback tells the students how they scored and what the correct answers are to the questions they missed. Students are then able to e-mail their results directly to their instructor, if desired. Acknowledgments The development of a textbook draws upon the contributions of many individuals. First, we would like to thank our students and former students at Arizona State University, xii Preface Miami University, the University of Alabama, and the University of Vermont. They provided important input and feedback when selected concepts or chapters were originally class tested. We would also like to thank our colleagues at each of these institutions for their assistance and support. Second, we express our gratitude to several distinguished colleagues who carefully reviewed the volume and provided incisive comments and valuable suggestions that improved the tenth edition. They include: Blaine Branchik, Quinnipiac University; Brian Brown, University of Massachusetts, Amherst; Abbie Griffin, University of Utah; Peter A. Reday, Youngstown State University; Larry P. Schramm, Oakland University; Judy Wagner, East Carolina University; and Jianfeng Wang, Mansfield University of Pennsylvania. We would also like to express our continuing appreciation to others who provided important suggestions that helped shape earlier editions: Kenneth Anselmi, East Carolina University; Joseph A. Bellizzi, Arizona State University; Paul D. Boughton, Saint Louis University; Michael R. Czinkota, Georgetown University; S. Altan Erdem, University of Houston–Clear Lake; Troy Festervand, Middle Tennessee State University; Srinath Gopalakrishna, University of Missouri, Columbia; Paris A. Gunther, University of Cincinnati; Jon M. Hawes, University of Akron; Jonathan Hibbard, Boston University; Lee Hibbert, Freed-Hardeman University; George John, University of Minnesota; Joe H. Kim, Rider University; Kenneth M. Lampert, Metropolitan State University, Minnesota; Jay L. Laughlin, Kansas State University; J. David Lichtenthal, Baruch College; Gary L. Lilien, Pennsylvania State University; Lindsay N. Meredith, Simon Fraser University; K. C. Pang, University of Alabama at Birmingham; Richard E. Plank, University of South Florida; Constantine Polytechroniou, University of Cincinnati; Bernard A. Rausch, Illinois Institute of Technology; David A. Reid, The University of Toledo; Paul A. Roobol, Western Michigan University; Beth A. Walker, Arizona State University; Elizabeth Wilson, Suffolk University; James F. Wolter, Grand Valley State University; Ugut Yucelt, Pennsylvania State University at Harrisburg; and John M. Zerio, American Graduate School of International Management. We are especially indebted to four members of the Board of Advisors for Arizona State University’s Center for Services Leadership. Each served as a senior executive sponsor for a funded research study, provided access to the organizations, and contributed valuable insights to the research. Collectively, these studies sharpened the strategy content of the volume. Included here are Michael Daniels, Senior Vice President, Global Technology Services, IBM Global Services; Greg Reid, Chief Marketing Officer, YRC Worldwide Inc.; Adrian Paull, Vice President, Customer Product Support, Honeywell Aerospace; and Merrill Tutton, President, AT&T UK, retired. We would like to thank Jim Ryan, President and Chief Executive Officer, W. W. Grainger, for his insights and contributions to this edition. We would also like to thank Mohan Kuruvilla, Adjunct Professor, Indian Institute of Management Kozhikode, for his keen insights and recommendations. We also extend our special thanks to Dr. Joseph Belonax, Western Michigan University, for contributing ideas and content to the teaching package. The talented staff of South-Western/Cengage Learning displayed a high level of enthusiasm and deserves special praise for their contributions in shaping this edition. In particular, Mike Roche provided valuable advice and keen insights for this edition. In turn, we were indeed fortunate to have Erin Berger, our development editor, on our team. Her steady hand, efficient style, and superb coordinating skills advanced the project. Pamela Rockwell contributed excellent copyediting skills and Melissa Sacco, Preface xiii our Project Manager, provided a confident style and a seasoned approach during the production process. We express our gratitude to Diane A. Davis, Arizona State University, for lending her superb administrative skills and creative talent to the project and for delivering under pressure. Finally, but most importantly, our overriding debt is to our wives, Rita and Sara, whose encouragement, understanding, and direct support were vital to the completion of this edition. Their involvement and dedication are deeply appreciated. Michael D. Hutt Thomas W. Speh ABOUT THE AUTHORS Michael D. Hutt (PhD, Michigan State University) is the Ford Motor Company Distinguished Professor of Marketing at the W. P. Carey School of Business, Arizona State University. He has also held faculty positions at Miami University (Ohio) and the University of Vermont. Dr. Hutt’s teaching and research interests are concentrated in the areas of businessto-business marketing and strategic marketing. His current research centers on the crossfunctional role that marketing managers assume in the formation of strategy. Dr. Hutt’s research has been published in the Journal of Marketing, Journal of Marketing Research, MIT Sloan Management Review, Journal of Retailing, Journal of the Academy of Marketing Science, and other scholarly journals. He is also the co-author of Macro Marketing ( John Wiley & Sons) and contributing author of Marketing: Best Practices (South-Western). Assuming a variety of leadership roles for American Marketing Association programs, he co-chaired the Faculty Consortium on Strategic Marketing Management. He is a member of the editorial review boards of the Journal of Business-to-Business Marketing, Journal of Business & Industrial Marketing, Industrial Marketing Management, Journal of the Academy of Marketing Science, and Journal of Strategic Marketing. For his 2000 contribution to MIT Sloan Management Review, he received the Richard Beckhard Prize. Dr. Hutt has consulted on marketing strategy issues for firms such as IBM, Motorola, Honeywell, AT&T, Arvin Industries, ADT, and Black-Clawson, and for the food industry’s Public Policy Subcommittee on the Universal Product Code. Thomas W. Speh, PhD, is Professor of Marketing Emeritus and Associate Director of MBA Programs at the Farmer School of Business, Miami University (Ohio). Dr. Speh earned his PhD from Michigan State University. Prior to his tenure at Miami, Dr. Speh taught at the University of Alabama. Dr. Speh has been a regular participant in professional marketing and logistics meetings and has published articles in a number of academic and professional journals, including the Journal of Marketing, Sloan Management Review, Harvard Business Review, Journal of the Academy of Marketing Sciences, Journal of Business Logistics, Journal of Retailing, Journal of Purchasing and Materials Management, and Industrial Marketing Management. He was the recipient of the Beta Gamma Sigma Distinguished Faculty award for excellence in teaching at Miami University’s School of Business and of the Miami University Alumni Association’s Effective Educator award. Dr. Speh has been active in both the Warehousing Education and Research Council (WERC) and the Council of Logistics Management (CLM). He has served as president of WERC and as president of the CLM. Dr. Speh has been a consultant on strategy issues to such organizations as Xerox, Procter & Gamble, Burlington Northern Railroad, Sara Lee, J. M. Smucker Co., and Millenium Petrochemicals, Inc. xiv CASE CONTRIBUTORS Erin Anderson, INSEAD Bradley W. Brooks, Queens University of Charlotte Clayton M. Christensen, Harvard Business School Terry H. Deutscher, Richard Ivey School of Business Ali F. Farhoomand, University of Hong Kong John H. Friar, Northeastern University John B. Gifford, Miami University (Ohio) Raymond M. Kinnunen, Northeastern University Marc H. Meyer, Northeastern University David W. Rosenthal, Miami University (Ohio) David V. Rudd, Lebanon Valley College Susan Sieloff, Northeastern University Robert E. Spekman, Darden School of Business, University of Virginia David Weinstein, INSEAD John M. Zerio, Thunderbird School of Global Management xv CONTENTS IN BRIEF Preface PART I PART II PART III PART IV xvi vii THE ENVIRONMENT OF BUSINESS MARKETING 1 Chapter 1 A Business Marketing Perspective 3 Chapter 2 The Business Market: Perspectives on the Organizational Buyer 33 MANAGING RELATIONSHIPS IN BUSINESS MARKETING 61 Chapter 3 Organizational Buying Behavior 63 Chapter 4 Customer Relationship Management Strategies for Business Markets 91 ASSESSING MARKET OPPORTUNITIES 121 Chapter 5 Segmenting the Business Market and Estimating Segment Demand 123 FORMULATING BUSINESS MARKETING STRATEGY 151 Chapter 6 Business Marketing Planning: Strategic Perspectives 153 Chapter 7 Business Marketing Strategies for Global Markets 180 Chapter 8 Managing Products for Business Markets 208 Chapter 9 Managing Innovation and New Industrial Product Development 232 Contents in Brief PART V xvii Chapter 10 Managing Services for Business Markets 257 Chapter 11 Managing Business Marketing Channels 281 Chapter 12 E-Commerce Strategies for Business Markets 303 Chapter 13 Supply Chain Management 329 Chapter 14 Pricing Strategy for Business Markets 358 Chapter 15 Business Marketing Communications: Advertising and Sales Promotion 383 Chapter 16 Business Marketing Communications: Managing the Personal Selling Function 407 EVALUATING BUSINESS MARKETING STRATEGY AND PERFORMANCE Chapter 17 Marketing Performance Measurement 433 435 Cases 462 Name Index 609 Subject Index 619 CONTENTS Preface PART I vii THE ENVIRONMENT OF BUSINESS MARKETING Chapter 1 A Business Marketing Perspective Business Marketing Business Marketing Management Business Market Customers 3 4 5 6 B2B TOP PERFORMERS: Jim Ryan, President and Chief Executive Officer, W.W. Grainger, Inc. Business Markets versus Consumer-Goods Markets 7 7 B2B TOP PERFORMERS: Career Path for B2B CEOs: For Many, It Began in Marketing! 9 Creating the Customer Value Proposition Marketing’s Cross-Functional Relationships Characteristics of Business Markets Business and Consumer Marketing: A Contrast 10 11 13 14 Smucker: A Consumer and Business Marketer Distinguishing Characteristics A Relationship Emphasis The Supply Chain Supply Chain Management 15 16 16 17 18 Managing Relationships in the Supply Chain Commercial Enterprises as Consumers 19 21 INSIDE BUSINESS MARKETING: The iPhone: A Triumph of Supply Chain Management Too Classifying Goods for the Business Market Entering Goods Foundation Goods Facilitating Goods Business Marketing Strategy Illustration: Manufactured Materials and Parts Illustration: Installations Illustration: Supplies A Look Ahead Summary xviii 1 22 22 23 24 24 26 26 26 26 27 29 Contents xix Discussion Questions 29 Internet Exercises Case: R.I.M.’s BlackBerry and Apple’s iPhone: The Face-Off in the Business Market 30 New Strategy Directions Discussion Questions 31 32 Chapter 2 The Business Market: Perspectives on the Organizational Buyer 31 33 Commercial Enterprises: Unique Characteristics Distribution by Size Geographical Concentration 34 35 35 Classifying Commercial Enterprises The Purchasing Organization Goals of the Purchasing Function 36 37 38 INSIDE BUSINESS MARKETING: The Supply Chain for McNuggets Strategic Procurement 39 INSIDE BUSINESS MARKETING: Respond with Value-Based Selling Tools E-Procurement 43 39 Everyone Is Getting Wired Enhancing the Buyer’s Capabilities 44 44 45 Delivering Measurable Results Buying Direct and Indirect Goods Reverse Auctions 45 45 46 ETHICAL BUSINESS MARKETING: Gift Giving: “Buy Me These Boots and You’ll Get My Business” How Organizational Buyers Evaluate Potential Suppliers Governments: Unique Characteristics E-Government Influences on Government Buying Understanding Government Contracts Telling Vendors How to Sell: Useful Publications Purchasing Organizations and Procedures: Government Federal Buying A Different Strategy Required The Institutional Market: Unique Characteristics Institutional Buyers: Purchasing Procedures Dealing with Diversity: A Market-Centered Organization 47 47 47 49 49 49 50 50 52 53 53 54 57 xx Contents PART II Summary 57 Discussion Questions Internet Exercises 58 59 Case: Sealed Air Corporation: Delivering Packaging Solutions Discussion Questions 60 60 MANAGING RELATIONSHIPS IN BUSINESS MARKETING 61 Chapter 3 Organizational Buying Behavior 63 The Organizational Buying Process The Search Process New Task Straight Rebuy 65 66 67 68 Modified Rebuy Forces Shaping Organizational Buying Behavior Environmental Forces Organizational Forces Strategic Priorities in Purchasing 69 71 71 73 73 Organizational Positioning of Purchasing 75 INSIDE BUSINESS MARKETING: Go Digital to Target Buying Influentials Group Forces 77 77 INSIDE BUSINESS MARKETING: Innovate and Win with BMW Individual Forces 80 82 B2B TOP PERFORMERS: Delivering Customer Solutions The Organizational Buying Process: Major Elements Summary Discussion Questions 84 85 86 87 Internet Exercises Case: The Tablet PC for Nurses: A Mobile Clinical Assistant Discussion Questions Chapter 4 Customer Relationship Management Strategies for Business Markets Relationship Marketing Types of Relationships Value-Adding Exchanges Nature of Relationships Strategic Choices 88 89 90 91 92 93 94 94 94 Contents B2B TOP PERFORMERS: Understanding the Customer’s Business—The Key to Success Managing Buyer-Seller Relationships 95 95 Transactional Exchange 95 Collaborative Exchange Switching Costs 96 96 Strategy Guidelines Measuring Customer Profitability 97 99 Activity-Based Costing 99 Unlocking Customer Profitability The Profitable Few 99 100 Managing High- and Low-Cost-to-Serve Customers Managing Unprofitable Customers 101 103 Firing Customers Customer Relationship Management Acquiring the Right Customers 103 104 104 INSIDE BUSINESS MARKETING: Diversify a Customer Portfolio Too! Crafting the Right Value Proposition Instituting the Best Processes PART III xxi 106 107 109 Motivating Employees Learning to Retain Customers Strategic Alliances Accessing Complementary Skills Benefits of Strategic Alliances Determinants of Alliance Success 110 111 112 112 113 114 The Social Ingredients of Alliance Success Summary Discussion Questions Internet Exercises Case: Hewlett-Packard Challenges from a Diverse Mix of Demanding Customers 116 118 118 119 ASSESSING MARKET OPPORTUNITIES 121 Chapter 5 Segmenting the Business Market and Estimating Segment Demand Business Market Segmentation Requirements and Benefits Requirements Benefits 120 123 125 125 125 xxii Contents INSIDE BUSINESS MARKETING: How to See What’s Next 126 Bases for Segmenting Business Markets Macrolevel Bases 127 128 Microlevel Bases 131 B2B TOP PERFORMERS: Steering Customers to the Right Channel Illustration: Microsegmentation The Segmentation Process Choosing Market Segments INSIDE BUSINESS MARKETING: A Fresh Approach to Segmentation: Customer Service Segmentation Isolating Market Segment Profitability Implementing a Segmentation Strategy Estimating Segment Demand The Role of the Demand Estimation INSIDE BUSINESS MARKETINGL: Accurate Forecasts Drive Effective Collaboration between Boeing and Alcoa Methods of Forecasting Demand Qualitative Techniques 136 136 136 137 138 139 139 140 141 142 142 Quantitative Techniques CPFR: A New Collaborative Approach to Estimating Demand 144 145 Combining Several Forecasting Techniques Summary Discussion Questions Internet Exercises 146 147 147 148 Case: Federated Insurance: Targeting Small Businesses PART IV 133 Cultivating Business Relationships 149 149 Discussion Questions 150 FORMULATING BUSINESS MARKETING STRATEGY 151 Chapter 6 Business Marketing Planning: Strategic Perspectives Marketing’s Strategic Role The Hierarchy of Strategies Strategy Formulation and the Hierarchy 153 154 154 156 Contents INSIDE BUSINESS MARKETING: From Bullet-Point Plans to Strategic Stories at 3M Functionally Integrated Planning: The Marketing Strategy Center B2B TOP PERFORMERS: Cross-Functional Relationships: Effective Managers Deliver on Promises xxiii 158 158 159 The Components of a Business Model 160 Customer Interface Core Strategy 162 163 Strategic Resources The Value Network Strategic Positioning 164 164 Strategic Positioning Illustrated 166 167 Building the Strategy Plan The Balanced Scorecard Financial Perspective Customer Perspective Internal Business Process Perspective Strategy Map Summary Discussion Questions Internet Exercises Case: Microsoft Targets Small and Mid-Sized Businesses Challenging Intuit, Inc. Discussion Questions Chapter 7 Business Marketing Strategies for Global Markets Capturing Global Advantage in Rapidly Developing Economies Mapping Sources of Global Advantage The Cost Advantage The Market Access Advantage The Capabilities Advantage INSIDE BUSINESS MARKETING: How Offshore Outsourcing Affects Customer Satisfaction—and a Company’s Stock Price! The Outsourcing Decision Global Market Entry Options Exporting 165 168 168 170 171 173 175 176 177 178 178 179 180 181 182 183 186 187 188 189 190 190 xxiv Contents Contracting 191 Strategic Global Alliances (SGA) Joint Ventures 192 193 ETHICAL BUSINESS MARKETING: The Bribery Dilemma in Global Markets 194 Choosing a Mode of Entry 195 Multidomestic versus Global Strategies 195 B2B TOP PERFORMERS: General Electric Aircraft Engines: Global Strategy Means Help Your Customers Source of Advantage: Multidomestic versus Global Types of International Strategy A Strategic Framework Global Strategy 196 197 198 199 Build on a Unique Competitive Position Emphasize a Consistent Positioning Strategy 201 201 201 Establish a Clear Home Base for Each Distinct Business Leverage Product-Line Home Bases at Different Locations Disperse Activities to Extend Home-Base Advantages Coordinate and Integrate Dispersed Activities Managing Risk in Emerging Markets 201 202 202 202 203 Summary Discussion Questions 203 204 Internet Exercise Case: Schwinn: Could the Story Have Been Different? Alternative Reality One: Aim High 205 206 206 Alternative Reality Two: If You Can’t Beat Them, Join Them Discussion Question 206 207 Chapter 8 Managing Products for Business Markets Building a Strong B2B Brand Brand-Building Steps A Systems Model for Managing a Brand B2B TOP PERFORMERS: Corporate Brand Personality Traits of a Successful 21st-Century Business Product Quality and Customer Value Meaning of Quality Meaning of Customer Value Product Support Strategy: The Service Connection 208 209 210 212 214 215 215 216 218 Contents xxv Product Policy 218 Types of Product Lines Defined Defining the Product Market 218 219 B2B TOP PERFORMERS: BASF: Using Services to Build a Strong Brand Planning Industrial Product Strategy 221 221 Product Positioning The Process 221 Isolating Strategy Opportunities Product Positioning Illustrated 222 The Technology Adoption Life Cycle Types of Technology Customers INSIDE BUSINESS MARKETING: The Gorilla Advantage in High-Tech Markets Strategies for the Technology Adoption Life Cycle The Bowling Alley The Tornado 221 223 223 224 225 225 226 227 Main Street Summary 228 228 Discussion Questions Internet Exercise Case: Cisco TelePresence: The “As if you were there” Technology 229 230 231 Benefits The Price Tag 231 231 Discussion Questions 231 Chapter 9 Managing Innovation and New Industrial Product Development The Management of Innovation Induced Strategic Behavior Autonomous Strategic Behavior Product Championing and the Informal Network Conditions Supporting Corporate Entrepreneurship Managing Technology Classifying Development Projects A Product-Family Focus The Disruptive Innovation Model Illustration: A New-Market Disruption Innovation Winners in High-Technology Markets 232 233 234 234 236 238 238 239 239 240 243 243 xxvi Contents INSIDE BUSINESS MARKETING: Patching: The New Corporate Strategy in Dynamic Markets The New-Product-Development Process 245 246 What Drives a Firm’s New Product Performance? 246 Anticipating Competitive Reactions 248 Sources of New Product Ideas 248 B2B TOP PERFORMERS: IDEO: The Hits Just Keep on Coming! 249 Determinants of New Product Performance and Timeliness The Determinants of Success 251 251 Fast-Paced Product Development Summary Discussion Questions Internet Exercise Case: Steelcase Inc. Extends Reach to Growing Health-Care Market 252 253 254 255 256 Discussion Question 256 Chapter 10 Managing Services for Business Markets 257 Understanding the Full Customer Experience The Customer Experience Life Cycle Applying the Customer Experience Map 258 258 260 Customer Experience Management A Solution-Centered Perspective 260 260 INSIDE BUSINESS MARKETING: Do Service Transition Strategies Pay Off ? Benefits of Solution Marketing Business Service Marketing: Special Challenges Services Are Different Tangible or Intangible? Simultaneous Production and Consumption Service Variability Service Perishability Nonownership 262 262 263 264 264 265 265 266 266 INSIDE BUSINESS MARKETING: To Sell Jet Engines, Teach Your Customer How to Sell Aircraft Service Quality Dimensions of Service Quality Customer Satisfaction and Loyalty 267 268 268 268 Contents xxvii Service Recovery 269 Zero Defections Return on Quality 270 270 Marketing Mix for Business Service Firms Segmentation 271 271 Service Packages 272 Pricing Business Services Services Promotion 275 276 Services Distribution Developing New Services 277 277 Summary Discussion Questions Internet Exercise 278 278 279 Case: SafePlace Corporation Discussion Questions 280 280 Chapter 11 Managing Business Marketing Channels The Business Marketing Channel Direct Channels INSIDE BUSINESS MARKETING: IBM Uses the Internet to Collaborate with Channel Partners and Build Customer Loyalty Indirect Channels Integrated Multichannel Models 281 282 283 284 284 Participants in the Business Marketing Channel 285 287 Distributors Manufacturers’ Representatives 287 290 B2B TOP PERFORMERS: Why Intel Uses Reps Channel Design Step 1: Define Customer Segments Step 2: Customers’ Channel Needs by Segment Step 3: Assess the Firm’s Channel Capabilities Step 4: Benchmark to Competitors Step 5: Create Channel Solutions for Customers’ Latent Needs Step 6: Evaluate and Select Channel Options Crucial Points in Channel Transformation Channel Administration 291 292 293 293 294 294 295 295 295 296 xxviii Contents Selection of Channel Members 296 Motivating Channel Members Summary 297 299 Discussion Questions Internet Exercise 299 300 Case: SunPower’s Go-to-Market Strategy 301 Discussion Questions 301 Chapter 12 E-Commerce Strategies for Business Markets Defining E-Commerce Key Elements Supporting E-Commerce Intranets and Extranets 303 305 307 307 INSIDE BUSINESS MARKETING: Extending the Boundaries of E-Commerce: B2M (Business to Machines) E-Commerce The Strategic Role of E-Commerce E-Commerce as a Strategic Component 308 309 309 INSIDE BUSINESS MARKETING: UPS Delivers the Goods Using Sophisticated E-Commerce Technology 310 What the Internet Can Do The Internet: Strategy Still Matters Crafting an E-Commerce Strategy Delineating E-Commerce Objectives Specific Objectives of Internet Marketing Strategies B2B TOP PERFORMERS: GE Healthcare: Using the Web to Create New Services Internet Strategy Implementation The Internet Product INSIDE BUSINESS MARKETING: “Borrow Best Tactics From Consumer E-Commerce To Revamp Your B2B Site” Channel Considerations with Internet Marketing The Internet as a Channel Alternative The Effect of the Internet on Pricing Strategy The Internet and Customer Communication Summary Discussion Questions Internet Exercise Case: Using the Internet at W.W. Grainger Discussion Questions 310 311 312 314 314 316 316 316 318 320 321 322 322 324 325 326 327 328 Contents Chapter 13 Supply Chain Management xxix 329 The Concept of Supply Chain Management 331 Partnerships: The Critical Ingredient Supply Chain Management: A Tool for Competitive Advantage 332 333 Supply Chain Management Goals Benefits to the Final Customer 335 336 INSIDE BUSINESS MARKETING: When the Chain Breaks The Financial Benefits Perspective Information and Technology Drivers Successfully Applying the Supply Chain Management Approach 337 337 338 339 B2B TOP PERFORMERS: Making Supplier Relationships Work Successful Supply Chain Practices Logistics as the Critical Element in Supply Chain Management 340 340 341 Distinguishing Between Logistics and Supply Chain Management Managing Flows 342 342 The Strategic Role of Logistics Sales-Marketing-Logistics Integration Just-in-Time Systems Total-Cost Approach Calculating Logistics Costs 343 343 343 344 346 Activity-Based Costing Total Cost of Ownership Business-to-Business Logistical Service Logistics Service Impacts on the Customer Determining the Level of Service 346 346 346 347 348 Logistics Impacts on Other Supply Chain Participants Business-to-Business Logistical Management Logistical Facilities Transportation Inventory Management 348 349 349 350 352 INSIDE BUSINESS MARKETING: The Profit Impact of Inventory Management Third-Party Logistics Summary Discussion Questions Internet Exercise Case: Managing Logistics at Trans-Pro Discussion Question 353 353 355 355 356 357 357 xxx Contents Chapter 14 Pricing Strategy for Business Markets 358 The Meaning of Value in Business Markets 359 Benefits Sacrifices 360 360 Value-Based Strategies The Pricing Process in Business Markets 361 362 Price Objectives 362 Demand Determinants Value-Based Pricing Illustrated 363 Cost Determinants Competition 365 368 370 Pricing across the Product Life Cycle Pricing New Products 371 372 INSIDE BUSINESS MARKETING: Understanding the Economic Value of New Products Legal Considerations Responding to Price Attacks by Competitors 373 373 Evaluating a Competitive Threat Understanding the Rules of Competitive Strategy Competitive Bidding 374 374 376 377 Closed Bidding Open Bidding Strategies for Competitive Bidding Summary Discussion Questions 377 378 378 379 380 Internet Exercise Case: Price Like a Retailer, Not a Widget Maker 381 Discussion Questions Chapter 15 Business Marketing Communications: Advertising and Sales Promotion The Role of Advertising Integrated Communication Programs Enhancing Sales Effectiveness Increased Sales Efficiency Creating Awareness Interactive Marketing Communications 382 382 383 385 385 385 385 386 386 Contents xxxi What Business-to-Business Advertising Cannot Do 387 Managing Business-to-Business Advertising Defining Advertising Objectives 387 387 Written Objectives Determining Advertising Expenditures 388 389 Developing the Advertising Message 391 Selecting Advertising Media for Business Markets 392 INSIDE BUSINESS MARKETING: Viral Marketing Campaigns Create Buzz 393 B2B TOP PERFORMERS: Search Engine Marketing at Google: The Right Message, the Right Time 395 Direct Marketing Tools Measuring Advertising Effectiveness 396 397 Measuring Impacts on the Purchase Decision The Measurement Program Managing Trade Show Strategy 398 398 400 Trade Shows: Strategy Benefits Trade-Show Investment Returns 400 401 Planning Trade-Show Strategy Trade-Show Objectives Selecting the Shows Managing the Trade-Show Exhibit Evaluating Trade-Show Performance Summary Discussion Questions Internet Exercise 401 402 402 402 403 404 405 405 Case: Johnson Controls, Inc. Discussion Questions 406 406 Chapter 16 Business Marketing Communications: Managing the Personal Selling Function Relationship Marketing Strategy Drivers of Relationship Marketing Effectiveness Relationship Marketing (RM) Programs Financial Impact of RM Programs Targeting RM Programs Managing the Sales Force Organizing the Personal Selling Effort 407 409 409 411 411 412 413 413 xxxii Contents Key Account Management 414 National Account Success 417 B2B TOP PERFORMERS: Using Customized Strategies to Outmaneuver Rivals Isolating the Account Management Process PART V 418 418 Account Management Success Sales Administration 419 421 Recruitment and Selection of Salespersons Training 421 421 Supervision and Motivation Evaluation and Control Models for Business-to-Business Sales Force Management 422 425 426 Deployment Analysis: A Strategic Approach Summary 426 429 Discussion Questions Internet Exercise Case: Account Management at YRC Worldwide: Choosing Customers Wisely Discussion Question 429 430 EVALUATING BUSINESS MARKETING STRATEGY AND PERFORMANCE Chapter 17 431 431 433 Marketing Performance Measurement 435 A Strategy Map: Portrait of an Integrated Plan Developing the Strategy: The Process Maps: A Tool for Strategy Making 437 438 441 Marketing Strategy: Allocating Resources Guiding Strategy Formulation Managing Individual Customers for Profit 441 442 The Marketing Control Process Control at Various Levels Strategic Control Annual Plan Control Marketing Control: The Marketing Performance Dashboard Efficiency and Effectiveness Control Profitability Control Implementation of Business Marketing Strategy 442 443 443 443 446 446 448 449 451 Contents INSIDE BUSINESS MARKETING: Tracking Marketing Success at Siemens The Strategy-Implementation Fit Implementation Skills xxxiii 452 452 453 The Marketing Strategy Center: An Implementation Guide 454 Looking Back 455 B2B TOP PERFORMERS: Cross-Functional Relationships: Effective Managers Deliver on Promises Summary 456 457 Discussion Questions 458 Internet Exercise Case: Intuit Leads in the Accounting Software Market 459 460 Discussion Question 460 Cases 461 Case Planning Guide Columbia Industries, Inc. Clariant Corporation Marketing 461 462 471 Circuit Board Corporation 3M Canada: Industrial Business Division Fedex Corp.: Structural Transformation through e-business Clearwater Technologies Barro Stickney, Inc. 486 499 515 535 541 We’ve Got Rhythm! Medtronic Corporation’s Cardiac Pacemaker Business 547 Total Quality Logistics: Sales Force Management Telezoo (A): Feast or Famine? Van Leer Packaging Worldwide: The TOTAL Account (A) 565 583 595 Ethical Dilemmas in Business Marketing 607 Name Index 609 Subject Index 619 This page intentionally left blank PART I THE ENVIRONMENT OF BUSINESS MARKETING 1 This page intentionally left blank CHAPTER 1 A Business Marketing Perspective The business market poses special challenges and significant opportunities for the marketing manager. This chapter introduces the complex forces that are unique to the business marketing environment. After reading this chapter, you will understand: 1. the dynamic nature of the business marketing environment and the basic similarities and differences between consumer-goods and business marketing. 2. the underlying factors that influence the demand for industrial goods. 3. the nature of buyer-seller relationships in a product’s supply chain. 4. the types of customers in this important market. 5. the basic characteristics of industrial products and services. 3 4 Part I The Environment of Business Marketing Business Marketing Business marketers serve the largest market of all: The dollar volume of transactions in the industrial or business market significantly exceeds that of the ultimate consumer market. In the business market, a single customer can account for an enormous level of purchasing activity. For example, the corporate procurement department at IBM spends more than $40 billion annually on industrial products and services.1 Others, such as Procter & Gamble, Apple, Merck, Dell, and Kimberly Clark each spend more than half of their annual sales revenue on purchased goods and services.2 Indeed, all formal organizations—large or small, public or private, for-profit or not-for-profit— participate in the exchange of industrial products and services, thus constituting the business market. Business markets are “markets for products and services, local to international, bought by businesses, government bodies, and institutions (such as hospitals) for incorporation (for example, ingredient materials or components), for consumption (for example, process materials, office supplies, consulting services), for use (for example, installations or equipment), or for resale. . . . The only markets not of direct interest are those dealing with products or services which are principally directed at personal use or consumption such as packaged grocery products, home appliances, or consumer banking.”3 The factors that distinguish business marketing from consumer marketing are the nature of the customer and how that customer uses the product. In business marketing, the customers are organizations (businesses, governments, institutions). Business firms buy industrial goods to form or facilitate the production process or use as components for other goods and services. Government agencies and private institutions buy industrial goods to maintain and deliver services to their own market: the public. Industrial or business marketing (the terms can be used interchangeably) accounts for more than half the economic activity in the United States, Canada, and most other nations. More than 50 percent of all business school graduates join firms that compete directly in the business market. The heightened interest in high-technology markets—and the sheer size of the business market—has spawned increased emphasis on business marketing management in universities and corporate executive training programs.4 This book explores the business market’s special opportunities and challenges and identifies the new requirements for managing the marketing function in this vital sector of the global economy. The following questions establish the theme of this first chapter: What are the similarities and differences between consumer-goods marketing 1 Tim Ferguson, “IBM Shifts Procurement HQ to China,” ZDNet News: October 13, 2006, accessed at http://www .news.zdnet.com on June 1, 2008. 2 Chip W. Hardt, Nicolas Reinecke, and Peter Spiller, “Inventing the 21st Century Purchasing Organization,” The McKinsey Quarterly (4, 2007): pp. 115–117. 3 Prospectus for the Institute for the Study of Business Markets, College of Business Administration, the Pennsylvania State University and J. David Lichtenthal, Venkatapparao Mummaleni, and David T. Wilson, “The Essence of Business Marketing Theory, Research, and Tactics: Contributions from the Journal of Business-to-Business Marketing,” Journal of Business-to-Business Marketing 15 (2, 2008): pp. 91–123. 4 J. David Lichtenthal, “Business-to-Business Marketing in the 21st Century,” Journal of Business-to-Business Marketing 12 (1, 2, 1998): pp. 1–5; J. Lichtenthal, “Advocating Business Marketing Education: Relevance and Rigor—Uttered as One,” Journal of Business-to-Business Marketing 14 (1, 2007): pp. 1–12; and Michael D. Hutt and Thomas W. Speh, “Business Marketing Education: A Distinctive Role in the Undergraduate Curriculum,” Journal of Business-to-Business Marketing 12 (1, 2, 1998): pp. 103–126. Chapter 1 FIGURE 1.1 A Business Marketing Perspective 5 POWERFUL B2B BRANDS Text not available due to copyright restrictions SOURCES: Caterpillar: Reprinted courtesy of Caterpillar, Inc. 3M: Courtesy of 3M. DUPONT: Copyright © 2005 DuPont. All rights reserved. The DuPont Oval Logo is a registered trademark of DuPont and its affiliates. Used by permission. and business marketing? What customers constitute the business market? How can the multitude of industrial goods be classified into manageable categories? What forces influence the behavior of business market demand? Business Marketing Management Many large firms that produce goods such as steel, production equipment, or computermemory chips cater exclusively to business market customers and never directly interact with their ultimate consumers. Other firms participate in both the consumergoods and the business markets. The introduction of laser printers and personal computers brought Hewlett-Packard, historically a business-to-business marketer, into the consumer market. Conversely, lagging consumer markets prompted Sony Corporation to expand to the business market by introducing office automation products. Both companies had to reorient their marketing strategies dramatically because of significant differences in the buying behavior of consumer versus business markets. Products like cell phones, office furniture, personal computers, and software are purchased in both the consumer and the business markets. What distinguishes business marketing from consumer-goods marketing is the intended use of the product and the intended consumer. Sometimes the products are identical, but a fundamentally different marketing approach is needed to reach the organizational buyer. Interestingly, some of the most valuable brands in the world belong to business marketers: Cisco, Google, BlackBerry, Caterpillar, IBM, FedEx, GE, DuPont, Intel, Hewlett-Packard, and 3M5 (Figure 1.1). 5 Frederick E. Webster, Jr. and Kevin Lane Keller, “A Roadmap for Branding in Industrial Markets,” Journal of Brand Management 11 (May 2004): pp. 388–402; and Matthew Schwartz, “B to B’s Best: Brands,” B to B, Special Issue (2007), accessed at http://www.btobonline on May 15, 2008. 6 Part I The Environment of Business Marketing FIGURE 1.2 THE CONSUMER MARKET (B2C) AND THE BUSINESS MARKET (B2B) AT DELL Dell, Inc. B2C Customers Individuals & Households Selected Products PCs Printers Consumer Electronics Simple Service Agreements B2B Businesses • Global • Large corporations • Small & Medium-sized businesses Institutions • Health care • Education Government • Federal • State • Local PCs Enterprise Storage Servers Complex Service Offerings Business Market Customers Business market customers can be broadly classified into three categories: (1) commercial enterprises—that is, businesses; (2) institutions—for example, universities; and (3) government. Consider Dell, Inc.: The firm serves both the business market (B2B) and the consumer market (B2C) (Figure 1.2). Importantly, however, more than 80 percent of its sales come from B2B customers! Dell serves each sector of the business market.6 First, the firm has developed close relationships with large global enterprises, like Boeing, and large corporate customers. These customers purchase thousands of personal computers (PCs) and now turn to Dell for a full range of information technology (IT) products and services. The volume of business coming from a single business customer can be huge: One customer bought 20,000 laptop computers for its global sales organization, and some enterprises have an installed base of more than 100,000 Dell computers. Second, small and medium-sized businesses (SMB) represent a substantial market, and Dell demonstrates special skills in understanding and reaching these customers. SMB firms now represent more than 1 million of Dell’s customers in the United States, and this base is growing rapidly around the world. Third, the firm serves the government market at all levels as well as institutional customers like universities and health-care organizations. Across each of its market sectors, a worldwide shift in demand from desktop computers to mobility products, including notebooks, is fueling rapid growth for Dell in India and China as well as in Europe, the Middle East, and Africa.7 To compensate for the maturing PC business, Dell has also 6 V. Kasturi Rangan and Marie Bell, “Dell—New Horizons,” Harvard Business School Case #9–502–022, October 10, 2002 (Boston, MA: Harvard Business School Publishing). 7 Daniel Workman, “Dell Computer International Sales,” suite101.com, June 22, 2008, accessed at http:// multinationalexpansion.suite101.com/article.cfm/dell_computer_international_sales on June 28, 2008. Chapter 1 A Business Marketing Perspective 7 B2B TOP PERFORMERS Jim Ryan, President and Chief Executive Officer, W.W. Grainger, Inc. W.W. Grainger, Inc. (NYSE: GWW), with sales of $6.5 billion, is the leading broad line supplier of facilities maintenance products serving businesses and institutions throughout North America. Through its network of nearly 600 branches, 18 distribution centers, and multiple Web sites, Grainger helps customers save time and money by providing them with the right products to keep their facilities running. Jim Ryan was elected to group president of Grainger in 2004, president of Grainger in 2006, chief operating officer in 2007, adding the title of chief executive officer in 2008. Ryan’s career at Grainger is testimony to his philosophy that “you prepare to be a leader by deliberately taking on unfamiliar and difficult assignments—those that many shy away from. Challenging assignments are the training ground that provides the highest level of learning, preparing you for leadership at the top levels of large companies.” Jim’s rise through the ranks of Grainger includes senior assignments in IT, Grainger Parts, Marketing, Sales & Service, and the company’s eBusiness. While in IT, Ryan oversaw the implementation of the SAP system and achieved corporate Y2K compliance. Both of these accomplishments reflect Ryan’s focus on seeking out challenging undertakings. Grainger’s success is focused on helping its customers reduce the overall acquisition costs for maintenance, repair, and operating (MRO) items. Grainger encourages customers to eliminate their inventories of MRO items and rely on Grainger’s responsive distribution systems and expertise to provide these items just when they are needed, reducing the acquisition costs of these indirect materials. Grainger’s philosophy is to be “customer intimate,” where a customer’s and a supplier’s (Grainger) processes are fully integrated so that the customer becomes more efficient. Essentially, Grainger seeks to reduce the customer’s total costs of acquiring MRO products. Ryan believes that students preparing to be future leaders of B2B companies can best prepare for that role by developing four skills during their college education: (1) discipline and a strong work ethic; (2) cultivating “people skills”; (3) building analytical skills; and (4) organizational skills. He advises young people to focus on the strong work ethic early in their careers and to accept tough jobs other managers are not interested in tackling. Echoing his own tactics, Ryan advises students that “you learn the critical management skills when you take on those assignments that are unfamiliar and complicated.” His accomplishments as a leader of a successful company are testimony to the wisdom of his approach. SOURCE: Reprinted by permission of Grainger. expanded the scope of its product offerings to include a broader array of IT products, including servers and data storage for the business market, and a growing list of consumer electronics products, such as flat-screen TVs and Global Positioning Systems (GPS), for the consumer market. Business Markets versus Consumer-Goods Markets The basic task of management cuts across both consumer-goods and business marketing. Marketers serving both sectors can benefit by rooting their organizational plan in 8 Part I The Environment of Business Marketing a market orientation, which requires superior proficiency in understanding and satisfying customers.8 Such market-driven firms demonstrate • a set of values and beliefs that places the customers’ interests first9; • the ability to generate, disseminate, and productively use superior information about customers and competitors10; • the coordinated use of interfunctional resources (for example, research and development, manufacturing).11 Distinctive Capabilities A close examination of a market-driven firm reveals two particularly important capabilities: market sensing and customer linking.12 First, the market-sensing capability concerns how well the organization is equipped to continuously sense changes in its market and anticipate customer responses to marketing programs. Market-driven firms spot market changes and react well in advance of their competitors (for example, Coca-Cola in the consumer-goods market and 3M in the business market). Second, the customer-linking capability comprises the particular skills, abilities, and processes an organization has developed to create and manage close customer relationships. Consumer-goods firms, such as Procter & Gamble (P&G), demonstrate these capabilities in working with powerful retailers like Wal-Mart. Here, multifunctional teams in both organizations work together by sharing delivery and product-movement information and by jointly planning promotional activity and product changes. Although evident in manufacturer-reseller relations in the consumer-goods market, strong customer-linking capabilities are crucial in the business market, where close buyerseller relationships prevail. Leading business-to-business firms like IBM and HewlettPackard demonstrate distinctive customer-linking skills and Cisco has propelled its legendary record of growth by forging close working relationships with customers and channel partners alike. Managing Customers as Assets Marketing expenditures that were once viewed as short-term expenses are now being considered as customer assets that deliver value for the firm and its shareholders.13 As global competition intensifies, marketing managers are under increasing pressure to demonstrate the return on investment from marketing spending, deliver strong financial performance, and be more accountable to shareholders.14 To meet these performance standards, firms must develop and 8 George S. Day, “The Capabilities of Market-Driven Organizations,” Journal of Marketing 58 (October 1994): pp. 37–52; and Gary F. Gebhardt, Gregory S. Carpenter, and John F. Sherry, Jr., “Creating a Market Orientation: A Longitudinal, Multifirm, Grounded Analysis of Cultural Transformation,” Journal of Marketing 70 (October 2006): pp. 37–55. 9 Rohit Deshpande, John U. Farley, and Frederick E. Webster Jr., “Corporate Culture, Customer Orientation, and Innovativeness in Japanese Firms: A Quadrad Analysis,” Journal of Marketing 57 (January 1993): pp. 23–37. 10 Ajay K. Kohli and Bernard J. Jaworski, “Market Orientation: The Construct, Research Propositions, and Managerial Implications,” Journal of Marketing 54 (April 1990): pp. 1–18. 11 John C. Narver and Stanley F. Slater, “The Effect of a Market Orientation on Business Profitability,” Journal of Marketing 54 (October 1990): pp. 20–35. 12 Day, “Capabilities of Market-Driven Organizations,” pp. 37–52; and Girish Ramani and V. Kumar, “Interaction Orientation and Firm Performance,” Journal of Marketing 72 (January 2008): pp. 27–45. 13 V. Kumar and Werner Reinartz, Customer Relationship Management (Hoboken, NJ: John Wiley & Sons, 2006). 14 Frederick E. Webster, Jr., Alan J. Malter, and Shankar Ganesan, “The Decline and Dispersion of Marketing Competence,” MIT Sloan Management Review 46 (Summer 2005): pp. 35–43. Chapter 1 A Business Marketing Perspective 9 B2B TOP PERFORMERS Career Path for B2B CEOs: For Many, It Began in Marketing! Executives with a strong background in sales and marketing are taking the top position at leading business marketing firms. Why? Companies now place increased importance on customer relationships. “They’ve changed their sales strategies to emphasize building longterm partnerships with customers. And they’re building profitable businesses on the notion that it’s far cheaper to sell to current customers than it is to acquire new ones.” Sales and marketing executives understand customers, know the competitive landscape, and have keen insights concerning how to add value to the firm’s offerings and to the customer’s organization. That is why many firms are tapping sales and marketing executives for the CEO position. Here are three examples: • Cisco Systems—John Chambers began his career as an IBM salesperson where he learned the importance of listening carefully to customers and delivering on promises.1 • Xerox Corporation—Ann Mulcahy spent the majority of her 25 years at the firm in sales positions before being appointed president and CEO. • GE—In a 20-year career, Jeffrey Immelt held a variety of GE sales and marketing positions before being named to succeed Jack Welch as CEO. All of these CEOs have taken steps to make their respective organization more customer centered. For example, Jeffrey Immelt’s priorities for GE reflect his background in B2B marketing. These are “making sure all the processes work correctly, for example, so deliveries are always on time; ensuring that whatever GE’s proposition to the customer is, it will make that customer more money; and increasing the effectiveness of GE’s sales force.”2 Looking ahead, he seeks new leaders for growth at GE—people who are passionate about customers and innovation, people who really know markets and products.3 1 “Business Biographies: John T. Chambers,” http://www .answers.com, accessed on June 29, 2008. 2 Eilene Zimmerman, “So You Wanna Be a CEO,” Sales & Marketing Management (January 2002): pp. 31–35. 3 Patricia O’Connell, “Bringing Innovations to the Home of Six Sigma,” BusinessWeek Online, August 1, 2005, accessed at http:// www.businessweek.com. nurture customer relationship management capabilities, which include all the skills required to identify, initiate, develop, and maintain profitable customer relationships. Marketing Tasks: What Managers Do To bring the job of business marketing professionals to life, let’s examine some of the day-to-day assignments they perform. In customer relationship management, some critical marketing tasks include “identifying and categorizing customer segments; determining a customer’s current and potential needs; visiting customers to learn about the uses and applications of individual products; developing and executing the individual components of sales, advertising, promotion, and services programs; assessing price sensitivities; and determining customer response to rivals’ current and potential offerings.”15 Research clearly demonstrates that the customer relationship management process has an important impact on a firm’s financial performance. 15 Rajendra K. Srivastava, Tasadduq A. Shervauie, and Liam Fahey, “Marketing, Business Processes, and Shareholder Value: An Organizationally Embedded View of Marketing Activities and the Discipline of Marketing,” Journal of Marketing 63 (Special Issue, 1999): pp. 168–179. 10 Part I The Environment of Business Marketing Profit Focus Developing a firm grasp on the profit impact of marketing strategy actions is fundamental to the job of a business marketing manager. Included here is the need to isolate the forces that drive customer profitability, aligning resources spent on customers to the revenues and profit that will be secured. To this end, Robert S. Kaplan and David P. Norton assert: A company that forgets, or never realizes, that it has unprofitable products and customers in the current period will almost surely continue to incur losses in unprofitable products and customers in future periods. Having a clear picture about where the company is making money and losing money should be a vital input to any strategy review.16 Partnering for Increased Value A business marketer becomes a preferred supplier to major customers such as Apple, Texas Instruments, or Procter & Gamble by working closely as a partner, developing an intimate knowledge of the customer’s operations, and contributing unique value to that customer’s business. Business marketing programs increasingly involve a customized blend of tangible products, service support, and ongoing information services both before and after the sale. Market-driven firms place a high priority on customer-linking capabilities and closely align product decisions—as well as delivery, handling, service, and other supply chain activities— with the customer’s operations. For firms like Intel or Boeing to deliver maximum value to their customers, each must receive maximum value from its suppliers. For instance, Intel could not have achieved its commanding global market share without the cost, quality, technology, and other advances its suppliers contribute.17 Creating the Customer Value Proposition18 Business marketing strategy must be based on an assessment of the company, the competitor, and the customer. A successful strategy focuses on identifying those opportunities in which the firm can deliver superior value to customers based on its distinctive competencies. From this perspective, marketing can be best understood as the process of defining, developing, and delivering value. Market-driven firms attempt to match their resources, skills, and capabilities with particular customer needs that are not being adequately served. By understanding customer needs, marketing managers can define value from the customer’s perspective and convert that information into requirements for creating satisfied customers. In turn, a firm’s capabilities and skills determine the degree to which the company can meet these requirements and provide greater value than its competitors. A business marketing firm’s offering includes many technical, economic, service, or social benefits that provide value to customers—but so do the offerings of competitors. So, customers compare the value elements of a firm’s offering with those offered 16 Robert S. Kaplan and David P. Norton, The Execution Premium: Linking Strategy to Operations for Competitive Advantage (Boston, MA: Harvard Business Press, 2008), p. 258. 17 Gina Roos, “Intel Corporation: It Takes Quality to Be Preferred by World’s Biggest Chipmaker,” Purchasing 131 (November 15, 2001): pp. 21–22. 18 James C. Anderson, James A. Narus, and Wouter van Rossum, “Customer Value Propositions in Business Markets,” Harvard Business Review 84 (March 2006): pp. 91–99. Chapter 1 A Business Marketing Perspective 11 by the next best alternative.19 A customer value proposition captures the particular set of benefits that a supplier offers to advance the performance of the customer organization. Rather than merely attempting to list more benefits than competitors, “best practice suppliers base their value proposition on the few elements that matter most to target customers, demonstrate the value of this superior performance, and communicate it in a way that conveys a sophisticated understanding of the customer’s business priorities.”20 The building blocks of a successful value proposition include: • Points of parity—the value elements with essentially the same performance characteristics as the next best alternative; • Points of difference—the value elements that render the supplier’s offering either superior or inferior to the next best alternative. Value Proposition Illustrated Sonoco, a global packaging supplier headquartered in South Carolina, approached a large European customer, a producer of consumer goods, about redesigning the packaging for one of its successful product lines. Although the redesigned packaging provided several favorable points of difference relative to the next best alternative, Sonoco executives decided to place special emphasis on one point of parity and two points of difference in the customer value proposition: The redesigned packaging will deliver significantly greater manufacturing efficiency in the customer’s fill lines, through higher-speed closing, and provide a distinctive look that customers will find more appealing—all for the same price as the present packaging. What Matters Most? A point of parity was included in the value proposition because key buying influentials (those who have power in the buying process) within the customer organization would not even consider a packaging redesign if the price increased. The first point of difference in the value proposition (increased efficiency) delivered cost savings, allowing the customer to dramatically streamline its production schedule. The second point of difference (more distinctive customer packaging) enhanced the firm’s market position and appeal to its customers, allowing it to realize meaningful growth in its revenues and profit. While the other favorable points of difference were certainly mentioned in discussions with the customer organization, Sonoco executives chose to emphasize those points that mattered most to the customer. Marketing’s Cross-Functional Relationships Rather than operating in isolation from other functional areas, the successful business marketing manager is an integrator—one who understands manufacturing, research and development (R&D), and customer service and who applies these strengths in developing marketing strategies that respond to customer needs.21 Close and tightly integrated cross-functional relationships underlie the strategy success stories of firms such as Hewlett-Packard and 3M. As firms adopt leaner and more agile structures and emphasize cross-functional teams, the business marketing manager assumes an important and challenging role in strategy formation. 19 Wolfgang Ulaga and Andreas Eggert, “Value-Based Differentiation in Business Relationships: Gaining and Sustaining Key Supplier Status,” Journal of Marketing 70 (January 2006): pp. 119–136. 20 Anderson, Narus, and van Rossum, “Customer Value Propositions,” p. 93. 21 Michael D. Hutt, “Cross-Functional Working Relationships in Marketing,” Journal of the Academy of Marketing Science 23 (Fall 1995): pp. 351–357. 12 Part I The Environment of Business Marketing FIGURE 1.3 Illustrative Input Percent of capital budgeting requirements and ROI for a new product Accurate cost history and forecast of future costs by product and market segment Responsive delivery support consistent with customer needs BUSINESS MARKETING PLANNING: A FUNCTIONALLY INTEGRATED PERSPECTIVE Business Function Finance Accounting Business Function Illustrative Input R&D Concept and product development and evaluation Procurement Monitoring and interpretation of relevant trends in supply environment Manufacturing Forecast of production costs at alternative volume levels Customer Service Provision for technical service after the sale Business Marketing Planning Logistics Formulation of Business Marketing Strategy Working Relationships A day in the life of a business marketing manager centers on building relationships with customers and in forging one-to-one relationships with managers in the firm’s other functional areas. By building effective cross-functional connections, the marketer is ideally equipped to respond to customers’ changing needs. Business marketing success depends to a large degree on such functional areas in the firm as engineering, R&D, manufacturing, and technical service. Planning in the industrial setting thus requires more functional interdependence and a closer relationship to total corporate strategy than planning in the consumer-goods sector. B. Charles Ames points out that “changes in marketing strategy are more likely to involve capital commitments for new equipment, shifts in development activities, or departures from traditional engineering and manufacturing approaches, any one of which would have companywide implications.”22 All business marketing decisions—product, price, promotion, and distribution—are affected, directly or indirectly, by other functional areas. In turn, marketing considerations influence business decisions in R&D and in manufacturing and procurement, as well as adjustments in the overall corporate strategy. Business marketing planning must be coordinated and synchronized with corresponding planning efforts in R&D, procurement, finance, production, and other areas (Figure 1.3). 22 B. Charles Ames, “Trappings vs. Substance in Industrial Marketing,” Harvard Business Review 48 (July–August 1976): pp. 95–96. Chapter 1 A Business Marketing Perspective 13 Characteristics of Business Markets Business marketing and consumer-goods marketing are different. A common body of knowledge, principles, and theory applies to both consumer and business marketing, but because their buyers and markets function quite differently, they merit separate attention. Consumer and business marketing differ in the nature of markets, market demand, buyer behavior, buyer-seller relationships, environmental influences (economic, political, legal), and market strategy. Yet, the potential payoffs are high for the firm that can successfully penetrate the business market. The nature of the demand for industrial products poses unique challenges—and opportunities—for the marketing manager. Derived Demand Derived demand refers to the direct link between the demand for an industrial product and the demand for consumer products: The demand for industrial products is derived from the ultimate demand for consumer products. Consider the materials and components used in a Harley-Davidson motorcycle. Harley-Davidson manufactures some of the components, but the finished product reflects the efforts of more than 200 suppliers or business marketers who deal directly with the firm. In purchasing a Harley-Davidson motorcycle, the customer is stimulating the demand for a diverse array of products manufactured by business marketing firms—such as tires, electrical components, coil springs, aluminum castings, and other items. Fluctuating Demand Because demand is derived, the business marketer must carefully monitor demand patterns and changing buying preferences in the household consumer market, often on a worldwide basis. For example, a decline in mortgage rates can spark an increase in new home construction and a corresponding increase in appliance sales. Retailers generally respond by increasing their stock of inventory. As appliance producers like Maytag increase the rate of production to meet the demand, business marketers that supply these manufacturers with items such as motors, timers, or paint experience a surge in sales. A downturn in the economy creates the opposite result. This explains why the demand for many industrial products tends to fluctuate more than the demand for consumer products. Stimulating Demand Some business marketers must not only monitor final consumer markets but also develop a marketing program that reaches the ultimate consumer directly. Aluminum producers use television and magazine ads to point out the convenience and recycling opportunities that aluminum containers offer to the consumer—the ultimate consumer influences aluminum demand by purchasing soft drinks in aluminum, rather than plastic, containers. More than 4 billion pounds of aluminum are used annually in the production of beverage containers. Similarly, Boeing promotes the convenience of air travel in a media campaign targeted to the consumer market to create a favorable environment for longer-term demand for its planes; DuPont advertises to ultimate consumers to stimulate the sales of carpeting, which incorporates their product. Price Sensitivity Demand elasticity refers to the responsiveness of the quantity demanded to a change in price. Demand is elastic when a given percentage change in price brings about an even larger percentage change in the quantity demanded. Inelasticity results when demand is insensitive to price—that is, when the percentage change in demand is less than the percentage change in price. Consider the demand for electronic components that is stimulated by companies making electronic games. 14 Part I The Environment of Business Marketing As long as final consumers continue to purchase and upgrade these games and are generally insensitive to price, manufacturers of the equipment are relatively insensitive to the price of electronic components. At the opposite end of the spectrum, if consumers are price sensitive when purchasing soup and other canned grocery products, manufacturers of soup will be price sensitive when purchasing metal cans. Thus, the derived demand indicates that the demand for metal cans is price elastic. Final consumer demand has a pervasive impact on the demand for products in the business market. By being sensitive to trends in the consumer market, the business marketer can often identify both impending problems and opportunities for growth and diversification. A Global Market Perspective A complete picture of the business market must include a horizon that stretches beyond the boundaries of the United States. The demand for many industrial goods and services is growing more rapidly in many foreign countries than in the United States. Countries like Germany, Japan, Korea, and Brazil offer large and growing markets for many business marketers. In turn, China and India represent economies with exploding levels of growth. Countless small firms and many large ones—such as GE, 3M, Intel, Boeing, Dow Chemical, Caterpillar, and Motorola—derive a significant portion of their sales and profits from international markets. For example, China plans to invest more than $300 billion over the next few years in the country’s infrastructure, representing an enormous market opportunity for all of GE’s industrial businesses, including power generation, health care, and infrastructure (for example, water purification). For cell phone makers such as Motorola, China already represents a fiercely competitive market and features the world’s largest base of subscribers—well over 500 million.23 Global Challengers From China’s Lenovo (computers) and Baosteel to Brazil’s Embraer (light jets) and Petrobras (petroleum) and from India’s Infosys Technologies (IT services) to Mexico’s Cemex (building materials), a whole host of formidable rivals are emerging. The Boston Consulting Group (BCG) identified the 100 largest, most successful, and most influential firms that have achieved prominence in their rapidly developing markets and beyond.24 The resulting BCG Challenger 100 list includes firms from 14 countries, including 41 firms from China, 13 from Brazil, 7 from Mexico, and 6 from Russia. Interestingly, 34 provide industrial goods. Total revenue for the BCG 100 is growing over 30 percent a year and profit margins exceed those of large multinational firms in the United States, Japan, and Germany. Business-to-business firms must act decisively, compete aggressively, and seize market opportunities in rapidly developing global economies. Business and Consumer Marketing: A Contrast Many consumer-goods companies with a strong reputation in the consumer market decide to capitalize on opportunities they perceive in the business market. The move is often prompted by a maturing product line, a desire to diversify operations, or the strategic 23 Pete Engardio, “A New World Economy,” Business Week, August 22/29, 2005, pp. 52–58. 24 Harold L. Sirkin, James W. Hemerling, and Arindam K. Bhattacharya, Globality: Competing with Everyone from Everywhere for Everything (New York: Business Plus, 2008), pp. 23–24. Chapter 1 A Business Marketing Perspective 15 opportunity to profitably apply R&D or production strength in a rapidly growing business market. P&G, departing from its packaged consumer-goods tradition, is using its expertise in oils, fats, and pulps to diversify into fast-growing industries. The J. M. Smucker Company operates successfully in both the consumer and the business markets. Smucker, drawing on its consumer product base (jellies and preserves), produces filling mixes used by manufacturers of yogurt and dessert items. Marketing strawberry preserves to ultimate consumers differs significantly from marketing a strawberry filling to a yogurt manufacturer. Key differences are highlighted in the following illustration. Smucker: A Consumer and Business Marketer Smucker reaches the consumer market with a line of products sold through retail outlets. New products are carefully developed, tested, targeted, priced, and promoted for particular market segments. To secure distribution, the firm employs food brokers who call on both wholesale- and retail-buying units. The company’s own sales force reaches selected larger accounts. Achieving a desired degree of market exposure and shelf space in key retail food outlets is essential to any marketer of consumer food products. Promotional plans for the line include media advertising, coupons, special offers, and incentives for retailers. Pricing decisions must reflect the nature of demand, costs, and the behavior of competitors. In sum, the marketer must manage each component of the marketing mix: product, price, promotion, and distribution. The marketing mix takes on a different form in the business market. Attention centers on manufacturers that potentially could use Smucker products to produce other goods; the Smucker product will lose its identity as it is blended into yogurt, cakes, or cookies. Once Smucker has listed all the potential users of its product (for example, large food processors, bakeries, yogurt producers), the business marketing manager attempts to identify meaningful market segments that Smucker can profitably serve. A specific marketing strategy is developed for each market segment. When a potential organizational consumer is identified, the company’s sales force calls directly on the account. The salesperson may begin by contacting a company president but, at first, generally spends a great deal of time with the R&D director or the product-development group leader. The salesperson is thus challenged to identify the key buying influentials—those who have power in the buying process. Seniorlevel Smucker executives may also assist in the selling process. Armed with product specifications (for example, desired taste, color, calories), the salesperson returns to the Smucker R&D department to develop samples. Several months may pass before a mixture is finally approved. Next, attention turns to price, and the salesperson’s contact point shifts to the purchasing department. Because large quantities (truckloads or drums rather than jars) are involved, a few cents per pound can be significant to both parties. Quality and service are also vitally important. Once a transaction is culminated, the product is shipped directly from the Smucker warehouse to the manufacturer’s plant. The salesperson follows up frequently with the purchasing agent, the plant manager, and other executives. Product movement and delivery information is openly shared, and close working relationships develop between managers at Smucker and key decision makers in the buying organization. How much business can Smucker expect from this account? The performance of the new consumer product in the marketplace determines this: The demand for industrial goods is, as noted, derived from ultimate consumer demand. Note also the 16 Part I The Environment of Business Marketing importance of (1) developing a close and continuing working relationship with business market customers and (2) understanding the requirements of the total range of buying influentials in the target company. Distinguishing Characteristics The Smucker illustration spotlights some of the features that differentiate business marketing strategy from consumer-goods marketing strategy. The business marketer emphasizes personal selling rather than advertising (TV, newspaper) to reach potential buyers. Only a small portion of the business marketer’s promotional budget is likely to be invested in advertising, most commonly through trade journals or direct mail. This advertising, however, often establishes the foundation for a successful sales call. The industrial salesperson must understand the technical aspects of the organization’s requirements and how those requirements can be satisfied, as well as know who influences the buying decision and why. The business marketer’s product also includes an important service component. The organizational consumer evaluates the quality of the physical product and the quality of the attached services. Attention centers on the total package of benefits the consumer receives. Price negotiation is frequently an important part of the industrial buying/selling process. Products made to particular quality or design specifications must be individually priced. Business marketers generally find that direct distribution to larger customers strengthens relationships between buyer and seller. Smaller accounts can be profitably served through intermediaries—manufacturers’ representatives or industrial distributors. As the Smucker example illustrates, business marketing strategies differ from consumer-goods marketing strategies in the relative emphasis given to certain elements of the marketing mix. It is important to note that the example also highlights fundamental differences between the buyers in each market. In an organization, a variety of individuals influence the purchase decision. Several major questions confront Smucker’s business marketing manager: Who are key participants in the purchasing process? What is their relative importance? What criteria does each apply to the decision? Thus, the business marketer must understand the process an organization follows in purchasing a product and identify which organizational members have roles in this process. Depending on the complexity of the purchase, this process may span many weeks or months and may involve the participation of several organization members. The business marketer who becomes involved in the purchase process early may have the greatest chance for success. A Relationship Emphasis Relationships in the business market are often close and enduring. Rather than constituting the end result, a sale signals the beginning of a relationship. By convincing a large food processor such as General Foods to use its product, Smucker initiates a potential long-term business relationship. More than ringing up a sale, Smucker creates a customer! To maintain that relationship, the business marketer must develop an intimate knowledge of the customer’s operations and contribute unique value to its business. Relationship marketing centers on all marketing activities directed toward establishing, developing, and maintaining successful exchanges with customers.25 25 Robert M. Morgan and Shelby D. Hunt, “The Commitment-Trust Theory of Relationship Marketing,” Journal of Marketing 58 (July 1994): pp. 20–38. Chapter 1 FIGURE 1.4 A Business Marketing Perspective 17 CHARACTERISTICS OF BUSINESS MARKET CUSTOMERS Characteristic Example • Business market customers are comprised of commercial enterprises, institutions, and governments. • Among Dell’s customers are Boeing, Arizona State University, and numerous state and local government units. • A single purchase by a business customer is far larger than that of an individual consumer. • An individual may buy one unit of a software package upgrade from Microsoft while Citigroup purchases 10,000. • The demand for industrial products is derived from the ultimate demand for consumer products. • New home purchases stimulate the demand for carpeting, appliances, cabinets, lumber, and a wealth of other products. • Relationships between business marketers tend to be close and enduring. • IBM’s relationship with some key customers spans decades. • Buying decisions by business customers often involve multiple buying influences, rather than a single decision maker. • A cross-functional team at Procter & Gamble (P&G) evaluates alternative laptop personal computers and selects Hewlett-Packard. • While serving different types of customers, business marketers and consumer-goods marketers share the same job titles. • Job titles include marketing manager, product manager, sales manager, account manager. Building one-to-one relationships with customers is the heart of business marketing. Figure 1.4 provides a recap of key characteristics of business market customers. The Supply Chain Figure 1.5 further illuminates the importance of a relationship perspective in business marketing by considering the chain of suppliers involved in the creation of an automobile. Consider Honda Motor Company. At its Marysville, Ohio, auto assembly plant, Honda introduced many new concepts to the U.S. auto industry, including just-in-time parts delivery and a high level of flexible model construction. For instance, the Ohio plant can readily shift from the Acura TL luxury sedan to the Accord, based on customer demand.26 A new small-car plant in Indiana gives Honda further capacity to make Civic- and Accord-size vehicles—fuel-efficient models particularly coveted by auto buyers as gas prices increase. Across its seven plants in North America, Honda annually purchases more than $17 billion of parts and materials from U.S. suppliers.27 The relationships between the auto producers and their suppliers fall squarely into the business marketing domain. Similarly, business marketers such as TRW rely on a 26 Tom Krisher, “Honda Grows While U.S. Auto Industry Falters,” accessed at http://biz.yahoo.com on July 2, 2008. 27 “Honda’s First U.S. Auto Plant Celebrates 25 Years of Production,” November 1, 2007, accessed at http://www.world. honda.com on July 2, 2008. 18 Part I FIGURE 1.5 The Environment of Business Marketing THE SUPPLY CHAIN Upstream Suppliers (USX, DuPont) Suppliers of manufactured materials and parts such as sheet metal or plastic resin Direct Suppliers (TRW, Johnson Controls) Purchase input used in creating power-steering systems (TRW) or car seats (Johnson Controls) Business Marketing Auto Manufacturers (Ford, General Motors) Auto Buyers (Consumers) Purchase input used in creating automobiles Purchase automobiles Business Marketing Consumer Marketing (Individuals, Households) and Business Marketing (Organizations such as Fleet Buyers) whole host of others farther back on the supply chain for raw materials, components, and other support. Each organization in this chain is involved in the creation of a product, marketing processes (including delivery), and support and service after the sale. In performing these value-creating activities, each also affects the quality level of the Honda product. Michael Porter and Victor Millar observe that “to gain competitive advantage over its rivals, a company must either perform these activities at a lower cost or perform them in a way that leads to differentiation and a premium price (more value).”28 Supply Chain Management Supply chain management is a technique for linking a manufacturer’s operations with those of all of its strategic suppliers and its key intermediaries and customers to enhance efficiency and effectiveness. The Internet allows members of the supply chain all over the world to exchange timely information, exchange engineering drawings during new product development, and synchronize production and delivery schedules. The goal of supply chain strategy is to improve the speed, precision, and efficiency of manufacturing through strong supplier relationships. This goal is achieved through information sharing, joint planning, shared technology, and shared benefits. If the business marketer can become a valued partner in a customer’s supply chain, the rewards are substantial: The focus shifts from price to value and from products to solutions.29 To achieve these results, the business marketing firm must 28 Michael E. Porter and Victor E. Millar, “How Information Gives You Competitive Advantage,” Harvard Business Review 63 (July–August 1985): pp. 149–160; see also Michael E. Porter, Competitive Advantage (New York: The Free Press, 1985). 29 Marc Bourde, Charlie Hawker, and Theo Theocharides, “Taking Center Stage: The 2005 Chief Procurement Officer Survey” (Sommers, NY: IBM Global Services, 2005), pp. 1–13, accessed at http://www.ibm.com on July 15, 2005. Chapter 1 A Business Marketing Perspective 19 demonstrate the ability to meet the customer’s precise quality, delivery, service, and information requirements. Managing Relationships in the Supply Chain Customers in the business market place a premium on the business marketer’s supply chain management capabilities. IBM spends 85 percent of its purchasing dollars with 50 suppliers.30 Of particular importance to IBM is the quality of engineering support it receives from suppliers. IBM actively seeks supplier partners that will contribute fresh ideas, responsive service, and leading-edge technology to attract buyers of future IBM products. Similarly, Toyota excels at creating and sustaining supplier relationships. In fact, executives across industries want to emulate Toyota’s success in creating a base of suppliers who are unshakably loyal, committed to continuous improvement, and drive superior financial performance. Malte Kalkoffen and colleagues at the Boston Consulting Group undertook a broad study to uncover the factors that set Toyota apart from the rest of the industry.31 The results reveal valuable insights into the strategy path a business marketing manager can follow to develop and sustain a long-term relationship with a world-class customer like Toyota. How Toyota Builds Distinctive Supplier Relationships Suppliers consistently rank Toyota as the preferred customer among the auto manufacturers. Why? “Toyota allows them acceptable returns on their investments, is reliable in honoring its contract price agreements, supports suppliers in improving their operations, and provides an equitable split of any cost reductions they achieve. The fundamental principle . . . is simple but profound: treat all suppliers fairly.”32 Three other principles guide Toyota’s approach to supplier relations: 1. The company imposes stringent selection criteria to ensure that every supplier meets Toyota’s requirements in terms of cost, quality, and technology. Importantly, Toyota will select only those suppliers that are willing to establish long-term partnerships with the company. 2. The company retains critical new product development (NPD) and design knowledge in-house but uses a streamlined NPD process that features frequent interactions with suppliers to leverage their expertise and increase productivity for Toyota and suppliers alike. 3. Once an ongoing relationship with a supplier has been established, Toyota takes responsibility for helping that supplier firm to develop its capabilities and grow its business. For example, Toyota monitors the performance of its suppliers to an extensive degree, insisting that senior executives of each supplier organization be responsible for quality and performance outcomes. In turn, Toyota performs semiannual quality audits and provides consulting assistance and access to knowledge-sharing networks to enhance its suppliers’ capabilities. 30 James Carbone, “Reinventing Purchasing Wins Medal for Big Blue,” Purchasing 129 (September 16, 1999): pp. 45–46. 31 The following discussion is based on: Malte Kalkoffen, Zafar Momin, Xavier Mosquet, Jagjit Singh, and George Sticher, “Getting to Win-Win: How Toyota Creates and Sustains Best-Practice Supplier Relationships,” The Boston Consulting Group, Inc., September 2007, pp. 1–10, accessed at http://www.bcg.com on May 25, 2008. 32 Ibid., p. 1. 20 Part I FIGURE 1.6 “When working with Toyota, you can never be satisfied with the status quo – you need to always work on doing things better.” - a German supplier in Japan The Environment of Business Marketing SUPPLIERS’ PHILOSOPHY MUST FIT WITH TOYOTA’S Kaizen ∞ Commitment to continuously improving performance ∞ “Toyota is very well coordinated internally. Every function at Toyota is aware of all interactions with us, even when it is only related to one particular topic. Toyota expects the same from us.” - a Thai supplier Willingness to analyze root causes for all problems and correct them Consistent reasoning ∞ A factual basis for all decisions ∞ Deep understanding of the reasons behind each product design decision Cross-functional teaming ∞ A teambased working culture ∞ Sharing of information and knowledge ∞ Willingness to share details on costs, quality, and technology ∞ The involvement of management in all operational matters Responsiveness ∞ Prompt replies to all requests ∞ Reliable delivery of whatever is promised “Toyota engineers are very detail oriented, and they constantly ask very specific questions. They want to understand the reasoning behind every product specification.” – a European supplier “When Toyota has a request for you, they expect a response as soon as possible, even if it is over the weekend.” - a German supplier Transparency and openness in all discussions SOURCE: Malte Kalkoffen, Zafar Momin, Xavier Mosquet, Jagjit Singh, and George Sticher, “Getting to Win-Win: How Toyota Creates and Sustains Best-Practice Supplier Relationships,” The Boston Consulting Group, Inc., September 2007, p. 4; accessed at http://www.bcg .com on May 25, 2008. All rights reserved. Reproduced by permission. Winning with Toyota Toyota seeks those suppliers that can provide industry leadership on cost, quality, and technology. Likewise, potential suppliers must demonstrate a willingness to pursue a long-term partnership, and the philosophy that guides the supplier firm must be aligned with Toyota’s culture. In evaluating a supplier’s philosophical fit, five specific elements are explored: Kaizen (or continuous improvement), consistent reasoning, cross-functional teaming, sharing of information and knowledge, and responsiveness (see Figure 1.6). The selection process is based on Toyota’s belief that long-term relationships with familiar suppliers reduces transaction costs and creates more value than short-term ones. Developing and nurturing close, long-term relationships with customers is an important goal for the business marketer. Built on trust and demonstrated performance, these partnerships require open lines of communication between multiple layers of the buying and selling organizations. Quotes from business marketing executives who count Toyota as a strategic partner (customer), illustrate the nature of long-term relationships:33 “Toyota is tough as hell in negotiations, and we have to share every detail of our data with them—but they are fair, and they know that if we don’t make money, we can’t innovate for them.” “Toyota helped us dramatically improve our production system. We started by making one component, and as we improved, Toyota rewarded us with orders for more components. Toyota is our best customer.” 33 Ibid., p. 8. Chapter 1 A Business Marketing Perspective 21 Commercial Enterprises as Consumers Business market customers, as noted at the outset of the chapter, can be broadly classified into three categories: (1) commercial enterprises, (2) governmental organizations, and (3) institutions. Each is explored in Chapter 2. However, the supply chain concept provides a solid foundation for describing the commercial customers that constitute the business market. Commercial enterprises can be divided into three categories: (1) users, (2) original equipment manufacturers (OEMs), and (3) dealers and distributors. Users Users purchase industrial products or services to produce other goods or services that are, in turn, sold in the business or consumer markets. User customers purchase goods—such as computers, photocopiers, or automated manufacturing systems—to set up or support the manufacturing process. When purchasing machine tools from GE, an auto manufacturer is a user. These machine tools do not become part of the automobile but instead help to produce it. Original Equipment Manufacturers (OEMs) The OEM purchases industrial goods to incorporate into other products it sells in the business or ultimate consumer market. For example, Intel Corporation produces the microprocessors that constitute the heart of Dell’s personal computer. In purchasing these microprocessors, Dell is an OEM. Likewise, Apple is an OEM in purchasing a touch-screen controller from Broadcom Corp.—about $4 to $5 of content in every iPhone.34 Dealers and Distributors Dealers and distributors include commercial enterprises that purchase industrial goods for resale (in basically the same form) to users and OEMs. The distributor accumulates, stores, and sells a large assortment of goods to industrial users, assuming title to the goods it purchases. Handling billions of dollars worth of transactions each year, industrial distributors are growing in size and sophistication. The strategic role assumed by distributors in the business market is examined in detail in Chapter 11 (Channels). Overlap of Categories The three categories of commercial enterprises are not mutually exclusive. Their classification is based on the intended purpose the product serves for the customer. Ford is a user when purchasing a machine tool for the manufacturing process, but the same company is an OEM when purchasing radios to be installed in the ultimate consumer product. A marketer must have a good understanding of the diverse organizational consumers that make up the business market. Properly classifying commercial customers as users, OEMs, or dealers or distributors is an important first step to a sharpened understanding of the buying criteria that a particular commercial customer uses in evaluating an industrial product. Understanding Buying Motivations Consider the different types of commercial customers that purchase a particular industrial product such as electrical timing mechanisms. Each class of customer views the product differently because each purchases the product for a different reason. 34 Eric J. Savitz, “Battle for Smartphone Market Share Pressures Margins,” Barron’s, June 30, 2008, p. 37. 22 Part I The Environment of Business Marketing INSIDE BUSINESS MARKETING The iPhone: A Triumph of Supply Chain Management Too1 Creating an immediate buzz among consumers around the world, Apple’s iPhone was judged a triumph of design and flexibility, not to mention a cool, must-have product, before the first unit was sold. However, “a killer product is only successful if it gets to the right customer at the right price at the right time.”2 Many firms fail to reap the rewards of product innovation because they stumble on quality or fail to meet demand, disappointing loyal customers. In addition to demonstrating superior capabilities in new product development and marketing strategy execution, Apple excels at supply chain management. In its annual Supply Chain Top 25, AMR Research awarded Apple the number-one ranking among a formidable set of top-performing firms, such as Nokia, IBM, Procter & Gamble, Cisco, and Nike. The AMR Research report notes that the leading-edge performance of Apple “signifies an epic shift away from the 20th Century productionefficiency mentality to a new era based on ideas, design, and content. The iPhone maker took the top spot due to a sophisticated mix of brilliant industrial design, transcendent software interfaces, and consumable goods that are entirely digital.” This approach provides financial benefits in the form of extremely high inventory turns, minimal material or capacity limitations, and excellent profit margins. By forecasting demand accurately and synchronizing communication across the supply chain, Apple met the demands of its rabid fan base. 1 Unless otherwise noted, this discussion is based on Thomas Wailgum, “Study: Apple, Nokia, Dell Top Among Global Supply Chains,” CIO, May 29, 2008, accessed at http://www.cio .com on July 4, 2008. 2 Bob Trebilcock, “Supply Chain Lessons from iPhone,” Modern Materials Handling, July 27, 2007, accessed at http://www.mmh .com on July 4, 2008. A food-processing firm such as Pillsbury buys electrical timers for use in a high-speed canning system. For this customer, quality, reliability, and prompt and predictable delivery are critical. Whirlpool, an OEM that incorporates the industrial product directly into consumer appliances, is concerned with the effect of the timers on the quality and dependability of the final consumer product. Because the timers are needed in large quantities, the appliance manufacturer is also concerned about the producer’s production capacity and delivery reliability. Finally, an industrial distributor is most interested in matching the capability of the timing mechanisms to the needs of customers (users and OEMs) in a specific geographical market. Classifying Goods for the Business Market35 Having classified business market customers, we must now ask what type of goods they require, and how each type is marketed. One useful method of classifying industrial goods is to ask the following questions: How does the industrial good or service enter the production process, and how does it enter the cost structure of the firm? The answer enables the marketer to identify those who are influential in the organizational buying process and to understand how to design an effective business marketing strategy. In general, industrial goods can be divided into three broad categories: entering goods, foundation goods, and facilitating goods (Figure 1.7). 35 Data on the dollar purchases of particular products by selected customers are drawn from Anne Millen Porter and Elena Epatko Murphy, “Hey Big Spender . . . The 100 Largest Industrial Buyers,” Purchasing (November 9, 1995): pp. 31–42. Chapter 1 A Business Marketing Perspective 23 CLASSIFYING GOODS FOR THE BUSINESS MARKET FIGURE 1.7 ENTERING GOODS FOUNDATION GOODS Raw Materials Installations – Farm Products (e.g., wheat) – Buildings & Land Rights (e.g., offices) – Natural Products (e.g., iron ore, lumber) – Fixed Equipment (e.g., computers, elevators) Manufactured Materials & Parts Accessory Equipment – Component Materials (e.g., steel) – Light Factory Equipment (e.g., lift trucks) – Component Parts (e.g., tires, microchips) – Office Equipment (e.g., desks, pc's) FACILITATING GOODS Supplies – Operating Supplies (e.g., lubricants, paper) – Maintenance & Repair Items (e.g., paint, screws) Business Services – Maintenance & Repair Services (e.g., computer repair) – Business Advisory Services (e.g., legal, advertising, management consulting) SOURCE: Adapted from Philip Kotler, Marketing Management: Analysis, Planning, and Control, 4th ed. (Englewood Cliffs, N.J.: Prentice-Hall, 1980), p. 172, with permission of Prentice-Hall, Inc. Entering Goods Entering goods become part of the finished product. This category of goods consists of raw materials and manufactured materials and parts. Their cost is an expense item assigned to the manufacturing process. 24 Part I The Environment of Business Marketing Raw Materials Observe in Figure 1.7 that raw materials include both farm products and natural products. Raw materials are processed only to the level required for economical handling and transport; they basically enter the buying organization’s production process in their natural state. Fueled by the massive growth in the Chinese economy, Freeport-McMoRan Copper & Gold Inc., the copper producer, has seen demand surge. McDonald’s uses more than 700 million pounds of potatoes each year and dictates the fortunes of many farmers in that agricultural segment. In fact, when attempting to introduce a raspberry sorbet, McDonald’s found, to its surprise, that not enough raspberries were being grown!36 Manufactured Materials and Parts In contrast to raw materials, manufactured materials and parts undergo more initial processing. Component materials such as textiles or sheet steel have been processed before reaching a clothing manufacturer or automaker but must be processed further before becoming part of the finished consumer product. Both Ford and GE spend more than $900 million annually on steel. Component parts, on the other hand, include small motors, motorcycle tires, and automobile batteries; they can be installed directly into another product with little or no additional processing. For example, Black & Decker spends $100 million each year on plastic parts, and Sun Microsystems spends more than $200 million on displays and monitors. Foundation Goods The distinguishing characteristic of foundation goods is that they are capital items. As capital goods are used up or worn out, a portion of their original cost is assigned to the production process as a depreciation expense. Foundation goods include installations and accessory equipment. Installations Installations include the major long-term investment items that underlie the manufacturing process, such as buildings, land rights, and fixed equipment. Large computers and machine tools are examples of fixed equipment. The demand for installations is shaped by the economic climate (for example, favorable interest rates) but is driven by the market outlook for a firm’s products. In the face of strong worldwide demand for its microprocessors, Intel is building new plants, expanding existing ones, and making significant investments in capital equipment. A typical semiconductor chip plant costs at least $3 billion to build, equipment accounting for $600 million of the cost and the land and building account for the rest.37 Accessory Equipment Accessory equipment is generally less expensive and is short-lived compared with installations, and it is not considered part of the fixed plant. This equipment can be found in the plant as well as in the office. Portable drills, personal computers, and fax machines illustrate this category. Facilitating Goods Facilitating goods are the supplies and services (see Figure 1.7) that support organizational operations. Because these goods do not enter the production process or become part of the finished product, their costs are handled as expense items. 36 James Brian Quinn, Intelligent Enterprise: A Knowledge and Service Based Paradigm for Industry (New York: The Free Press, 1992), p. 20. 37 Dean Takahashi, “Makers of Chip Equipment Beginning to Share the Pain,” The Wall Street Journal, August 14, 1996, p. B6. Chapter 1 A Business Marketing Perspective 25 Supplies Virtually every organization requires operating supplies, such as printer cartridges, paper, or business forms, and maintenance and repair items, such as paint and cleaning materials. These items generally reach a broad cross-section of industrial users. In fact, they are very similar to the kinds of supplies that consumers might purchase at a hardware or discount store. For example, along with products specifically designed for commercial use, Procter & Gamble (P&G) sells adaptations of its well-known consumer products in its professional division.38 Targeting the business market, customers here include hotels, fast-food restaurants, retailers, and health-care organizations. P&G senses a huge market opportunity—the U.S. market for janitorial and housekeeping cleaning products exceeds $3.2 billion annually. Services Says analyst James Brian Quinn, “As the service sector has grown to embrace 80 percent of all U.S. employment, specialized service firms have become very large and sophisticated relative to the scale and expertise that individual staff and service groups have within integrated companies.”39 To capture the skills of these specialists and to direct attention to what they do best, many firms are shifting or “outsourcing” selected service functions to outside suppliers. This opens up opportunities for firms that provide such services as computer support, payroll processing, logistics, food operations, and equipment maintenance. These specialists possess a level of expertise or efficiency that organizations can profitably tap. For example, Cisco Systems turned to FedEx to coordinate the movement of parts through its supply chain and on to the customer. By merging the parts shipments in transit for a single customer, the desired product can be assembled at the customer’s location, never spending a moment in a Cisco warehouse.40 Business services include maintenance and repair support (for example, machine repair) and advisory support (for example, management consulting or information management). Like supplies, services are considered expense items. Moreover, the explosive growth of the Internet has increased the demand for a range of electronic commerce services, from Web site design to the complete hosting of an e-commerce site. The Internet also provides a powerful new channel for delivering technical support, customer training, and advertising. For example, Intel is shifting over half of its advertising budget to online media and is asking its partners in the “Intel Inside” cooperative ad campaign, like Sony, to increase spending on online media.41 In turn, the Internet provides the opportunity to manage a particular activity or function from a remote, or even offshore, location. To illustrate, IBM manages the procurement functions for United Technologies Corporation via the Web.42 38 Ellen Byron, “Aiming to Clean Up, P&G Courts Business Customers,” The Wall Street Journal, January 26, 2007, pp. B1–B2. 39 James Brian Quinn, “Strategic Outsourcing: Leveraging Knowledge Capabilities,” Sloan Management Review 40 (Summer 1999): p. 9; see also, Mark Gottfredson, Rudy Puryear, and Stephen Phillips, “Strategic Sourcing: From Periphery to Core,” Harvard Business Review 83 (February 2005): pp. 132–139. 40 Douglas A. Blackman, “Overnight, Everything Changed for FedEx: Can It Reinvent Itself ?” The Wall Street Journal, November 4, 1999, pp. A1, A16. 41 Stuart Elliot, “As Customers Flock to the Web, Intel Gives Chase with Its Ad Budget,” The New York Times, October 10, 2007, p. C9. 42 Ira Sager, “Inside IBM: Internet Business Machines,” Business Week E.Biz, December 13, 1999, pp. ED21–23. 26 Part I The Environment of Business Marketing Business Marketing Strategy Marketing pattern differences reveal the significance of a goods classification system. A marketing strategy appropriate for one category of goods may be entirely unsuitable for another. Often, entirely different promotional, pricing, and distribution strategies are required. The physical nature of the industrial good and its intended use by the organizational customer dictate to an important degree the marketing program’s requirements. Some strategy highlights follow. Illustration: Manufactured Materials and Parts Recall that manufactured materials and parts enter the buying organization’s own product. Whether a part is standardized or customized often dictates the nature of marketing strategy. For custom-made parts, personal selling and customer relationship management activities assume an important role in marketing strategy. The value proposition centers on providing a product that advances the customer’s competitive position. The business marketer must also demonstrate strong supply chain capabilities. Standardized parts are typically purchased in larger quantities on a contractual basis, and the marketing strategy centers on providing a competitive price, reliable delivery, and supporting services. Frequently, industrial distributors are used to provide responsive delivery service to smaller accounts. For manufactured materials and parts, the marketer’s challenge is to locate and accurately define the unique needs of diverse customers, uncover key buying influentials, and create solutions to serve these customers profitably. Illustration: Installations Installations such as fixed equipment were classified earlier as foundation goods because they are capital assets that affect the buyer’s scale of operations. Here the product or technology itself, along with the service capabilities of the firm, are the central factors in marketing strategy, and direct manufacturer-to-user channels of distribution are the norm. Less costly, more standardized installations such as a drill press may be sold through marketing intermediaries. Once again, personal selling or account management is the dominant promotional tool. The salesperson or account team works closely with prospective organizational buyers. Negotiations can span several months and involve the top executives in the buying organization, especially for buildings or custom-made equipment. Customer buying motives center on economic factors (such as the projected performance of the capital asset) and emotional factors (such as industry leadership). A buyer may be quite willing to select a higher-priced installation if the projected return on investment supports the decision. The focal points for the marketing of installations include a strong customer relationship management effort, effective engineering and product design support, and the ability to offer a product or technology solution that provides a higher return on investment than its competition. Initial price, distribution, and advertising play lesser roles. Illustration: Supplies The final illustration centers on a facilitating good: supplies. Again we find different marketing patterns. Most supply items reach a broad market of organizational Chapter 1 A Business Marketing Perspective 27 customers from many different industries. Although some large users are serviced directly, a wide variety of marketing intermediaries are required to cover this broad and diverse market adequately. The goal of the business marketer is to secure a place on the purchasing function’s list of preferred or preapproved suppliers. Importantly, many firms are adopting e-procurement systems to dramatically streamline the process employees follow in buying supplies and other operating resources. From the desktop, an employee simply logs on to the system, selects the needed items from an electronic catalog of suppliers the purchasing function has preapproved, and sends the order directly to the supplier. For supplies, the marketer’s promotional mix includes catalog listings, advertising, and, to a lesser extent, personal selling. Advertising is directed to resellers (industrial distributors) and final users. Personal selling is less important for supplies than it is for other categories of goods with a high unit value, such as installations. Thus, personal selling efforts may be confined to resellers and large users of supplies. Price may be critical in the marketing strategy because many supply items are undifferentiated. However, customized service strategies might be designed to differentiate a firm’s offerings from those of competitors. By providing the right product assortment, timely and reliable delivery, and customized services, the business marketer may be able to provide distinctive value to the customer and develop a long-term, profitable relationship. A Look Ahead Figure 1.8 shows the chief components of the business marketing management process. Business marketing strategy is formulated within the boundaries established by the corporate mission and objectives. A corporation determining its mission must define its business and purpose, assess environmental trends, and evaluate its strengths and weaknesses. Building e-commerce capabilities and transforming these capabilities into offerings that provide superior customer value constitute vital corporate objectives at leading organizations like GE. Corporate objectives provide guidelines for forming specific marketing objectives. Business marketing planning must be coordinated and synchronized with corresponding planning efforts in R&D, procurement, finance, production, customer service, and other areas. Clearly, strategic plans emerge out of a bargaining process among functional areas. Managing conflict, promoting cooperation, and developing coordinated strategies are all fundamental to the business marketer’s interdisciplinary role. The business marketing management framework (see Figure 1.8) provides an overview of the five major parts of the text. This chapter introduced some of the features that distinguish industrial from consumer-goods marketing; the next chapter explores the major types of customers that make up the business market: commercial enterprises, governmental units, and institutions. Each sector represents a sizable market opportunity, presents special characteristics and needs, and requires a unique marketing strategy response. Part II examines the organizational buying process and the myriad forces that affect the organizational decision maker. Occupying a central position in Part II is customer relationship management—a managerial process that leading firms in business-to-business marketing have mastered. Here special attention is given to Part I FIGURE 1.8 The Environment of Business Marketing A FRAMEWORK FOR BUSINESS MARKETING MANAGEMENT Corporate Mission and Objectives Assess Market Opportunities Plan for and Acquire Marketing Information Commercial Market Government Market Institutional Market Analyze Organizational Buying Behavior Select Target Market Segments Evaluate Alternative Market Segments Monitor and Predict Environmental Influences (e.g., Economic, Political, Technological, Competitive) Domestic and International Marketing Objectives Strategy Development nal Pricing Personal Selling Advertising Sales Promotion inat ion e nt Channels of Distribution ctio n P rodu Marketing Program O th em Product or Service Coord er tom C us er vice S Inte r fu n Formulate the Business Marketing Mix ctio R&D 28 er P ro cu r Response of Target Market Segments Evaluation and Control the specific strategies that business marketers can follow in developing profitable relationships with customers. Part III turns to the selection of target segments and specific techniques for measuring the response of these segments. Part IV centers on designing market-driven strategies. Each component of the marketing mix is treated from the business marketing perspective. Special attention is given to creating and managing offerings and managing connections, including treatment of e-commerce and supply chain strategies. Particular emphasis is also given to defining value from the customer’s perspective and developing responsive pricing, advertising, and personal selling strategies to deliver that value proposition to target segments. The processes of implementing, monitoring, and controlling the marketing program are analyzed in Part V. A central theme is how business marketing managers can enhance profi tability by maximizing the return on marketing strategy expenditures. Chapter 1 A Business Marketing Perspective 29 Summary The business market offers significant opportunities and special challenges for the marketing manager. Market-driven firms in the business market demonstrate superior skill for understanding and satisfying customers. They also possess strong market-sensing and customer-linking capabilities. To deliver strong financial performance, businessto-business firms must also demonstrate customer relationship management skills, which include all the skills required to identify, initiate, develop, and monitor profitable customer relationships. Best-practice marketing strategists base their value propositions on the points of difference that matter the most to target customers, responding clearly and directly to the customer’s business priorities. Although a common body of knowledge and theory spans all of marketing, important differences exist between consumer and business marketing, among them the nature of markets, demand patterns, buyer behavior, and buyer-seller relationships. The dramatic worldwide rise in competition requires a global perspective on markets. To secure a competitive advantage in this challenging environment, business market customers are developing closer, more collaborative ties with fewer suppliers than they have used in the past. They are using the Internet to promote efficiency and realtime communication across the supply chain and demanding quality and speed from their suppliers to an unprecedented degree. These important trends in procurement place a premium on the supply chain management capabilities of the business marketer. Business marketing programs increasingly involve a customized blend of tangible products, service support, and ongoing information services both before and after the sale. Customer relationship management constitutes the heart of business marketing. The diverse organizations that make up the business market can be broadly divided into (1) commercial enterprises, (2) governmental organizations, and (3) institutions. Because purchases these organizational consumers make are linked to goods and services they generate in turn, derived demand is an important and often volatile force in the business market. Industrial goods can be classified into three categories, based on how the product enters the buying organization’s cost structure and the production process: (1) entering goods, (2) foundation goods, and (3) facilitating goods. Specific categories of goods may require unique marketing programs. Discussion Questions 1. Home Depot is quite busy each morning because local contractors, home remodelers, and other small-business customers are buying the products they require for the day’s projects. Such small-business customers represent a huge market opportunity for Home Depot or Lowe’s. Describe particular strategies these retailers could follow to target and serve these customers. 2. DuPont, one of the largest industrial producers of chemicals and synthetic fibers, spends millions of dollars annually on advertising its products to final consumers. For example, DuPont invested more than $1 million in a TV advertising blitz that emphasized the comfort of jeans made of DuPont’s stretch polyester-cotton blend. DuPont does not produce jeans or market them to final consumers, so why were large expenditures made on consumer advertising? 30 Part I The Environment of Business Marketing 3. What are the chief differences between consumer-goods marketing and business marketing? Use the following matrix as a guide in organizing your response: Consumer-Goods Marketing Business Marketing Customers Buying Behavior Buyer–Seller Relationship Product Price Promotion Channels 4. Explain how a company such as GE might be classified by some business marketers as a user customer but by others as an OEM customer. 5. Spending a day in the life of a marketing manager would demonstrate the critical importance of relationship management skills as that manager interacts with employees of other functional areas and, indeed, with representatives from both customer and supplier organizations. Explore the strategic significance of such relationships. 6. Describe the key elements of a customer value proposition. Next, explain how a compelling value proposition might include points of parity as well as points of difference. 7. Consumer products are frequently classified as convenience, shopping, or specialty goods. This classification system is based on how consumers shop for particular products. Would this classification scheme apply equally well in the business marketing environment? 8. Evaluate this statement: “The ways that leading companies manage time in the supply chain—in new product development, in production, in sales and distribution—are the most powerful new sources of competitive advantage.” 9. Evaluate this statement: “The demand for major equipment (a foundation good) is likely to be less responsive to shifts in price than that for materials, supplies, and components.” Do you agree or disagree? Support your position. 10. Many firms are shifting selected service functions to outside suppliers. For example, Harley-Davidson recently outsourced its transportation department function to UPS Supply Chain Solutions. What factors would prompt such a decision, and what criteria would a customer like Harley-Davidson emphasize in choosing a supplier? Internet Exercises 1. Many firms, large and small, have outsourced key functions, like payroll processing to ADP. Go to adp.com and (1) identify the range of services that ADP offers; (2) describe the types of customers the firm serves. 2. BASF “doesn’t make the products you buy, but makes them better.” Go to http:// www.basf.com and (1) outline the markets that BASF serves and (2) the products it sells. CASE R.I.M.’s BlackBerry and Apple’s iPhone: The Face-Off in the Business Market43 Research in Motion Ltd. (R.I.M.), the maker of the BlackBerry, is the North American leader in building smartphones, the versatile handsets that operate more like computers than phones. Once the exclusive domain of e-mail–obsessed professionals and managers across the business market, smartphones are now prized by consumers who want easy access to the Web and digital music and video even more than a mobile connection to their e-mail inbox. The iPhone introduction shifted the contours of the smartphone market toward consumers. An industry once dominated by technical discussions about enterprise security is now dominated by buzz around video games, sleek handset design, and mobile social networks. “That means that R.I.M., which has historically viewed big corporations and wireless carriers as its bedrock customers, needs to alter its DNA in a hurry” in order to retain its leadership position. In the first quarter of 2008, R.I.M. held 45 percent of the U.S. market for smartphones, compared with a nearly 20 percent share for Apple.44 The breakdown in sales indicates that BlackBerry dominates the corporate market and Apple’s iPhone is strong in the consumer market. New Strategy Directions To capitalize on its strong brand and leadership position in the smartphone industry, R.I.M. introduced two phones aimed exclusively at the consumer market: the BlackBerry Pearl and the Curve. Well received by consumers, the products met R.I.M.’s performance expectations and now account for a majority of R.I.M.’s device sales. In response, Apple now includes a software upgrade to allow iPhones to connect directly to corporate e-mail systems—a dagger aimed at the heart of R.I.M.’s strength in the business market. The upgrade also allows iPhone users to run customized applications to track inventory, record expenses, and perform other corporate tasks. So, R.I.M. is trying to capture some of the consumer market with the BlackBerry and Apple is attacking R.I.M. on its home turf by driving demand for the iPhone among corporate customers. Some experts suggest that R.I.M. offers several capabilities that Apple can’t yet match, including enhanced security and reliability for corporate users. For example, the company runs its own wireless network so it can make sure e-mails are delivered in a timely fashion.45 Yet, Apple demonstrates deep skills in product design, innovation, and branding. Simply stated, R.I.M.’s greatest challenge in the consumerdriven smartphone industry may come down to creating devices that people admire and embrace as much as the iPhone. 43 Unless otherwise noted, this discussion is based on Brad Stone, “BlackBerry’s Quest: Fend Off the iPhone,” The New York Times, April 27, 2008, pp. B1 and B4. 44 Jim Jubak, “New iPhone Shows Apple Still Gets It,” accessed at http://www.moneycentral.msn.com on June 6, 2008. 45 Arik Hesseldahl, “The iPhone Eyes BlackBerry’s Turf,” Business Week, June 23, 2008, p. 38. 31 32 Part I The Environment of Business Marketing Discussion Questions 1. Suggest possible strategies that Apple might follow to strengthen the position of the iPhone in the business market. In turn, what strategies could R.I.M. follow to strengthen the performance of the BlackBerry brand in the consumer market? 2. In your view, which brand will win the battle in the business market? In the consumer market? CHAPTER 2 The Business Market: Perspectives on the Organizational Buyer The business marketer must understand the needs of a diverse mix of organizational buyers drawn from three broad sectors of the business market—commercial enterprises, government (all levels), and institutions—as well as from an expanding array of international buyers. After reading this chapter, you will understand: 1. the nature and central characteristics of each of these market sectors. 2. how the purchasing function is organized in each of these components of the business market. 3. the dramatic role that online purchasing assumes in the business market. 4. the need to design a unique marketing program for each sector of the business market. 33 34 Part I The Environment of Business Marketing Cisco Systems, Inc., provides the networking solutions that are the foundation of the Internet and of most corporate, education, and government networks on a global scale. Today, the Internet and computer networking are a fundamental part of business, education, personal communications, and entertainment. Virtually all messages or transactions passing over the Internet are carried efficiently and securely through Cisco equipment. Cisco provides the hardware and software solutions for transporting data, voice, and video within buildings, across campuses, or around the world. Rather than serving individuals or household consumers, Cisco is a leading-edge business-to-business firm that markets its products and services to organizations: commercial enterprises (for example, corporations and telecommunications firms), governmental units, and institutions (for example, universities and health-care organizations). Marketing managers at Cisco give special attention to transforming complex technology products and services into concrete solutions to meet customer requirements. For example, when Pep Boys, the leading automotive aftermarket and service chain in the United States wanted to connect its 593 retail store locations across 36 states, Cisco provided the network solution.1 Likewise, when Procter & Gamble (P&G) wanted to launch a major Internet initiative to meet its aggressive growth targets, the firm turned to Cisco.2 The sales team from Cisco described how an efficient Internet strategy could improve the way companies interact with employees, suppliers, and customers. Working with Cisco, P&G implemented several initiatives, including an online system called “Web Order Management” that enables retail customers, like Target, to connect to P&G any time to place and manage orders on the Web. In working with Cisco, P&G Chief Information Officer (CIO) Steve David commented: “We like to hook our wagon to people who are the best so they can help us be the best at creating that all-important competitive advantage.”3 Each of the three business market sectors—commercial firms, institutions, and governments—has identifiable and unique characteristics that business marketers must understand if marketers wish to grow their client bases. A significant first step in creating successful marketing strategy is to isolate the unique dimensions of each major business market sector. How much market potential does each sector represent? Who makes the purchasing decisions? The answers provide a foundation on which managers can formulate marketing programs that respond to the specific needs and characteristics of each business market sector. Commercial Enterprises: Unique Characteristics Commercial enterprises include manufacturers, construction companies, service firms (for example, hotels), transportation companies, selected professional groups (for example, dentists), and resellers (wholesalers and retailers purchasing equipment and supplies to use in their operations). Manufacturers are the most important commercial customers: The 100 largest ones purchase more than $1 trillion of goods and services annually.4 1 Customer Success Story: “Cisco Helps Pep Boys Improve Point-of-Sale Applications, Security Posture, and Future Flexibility,” http://www.cisco.com, accessed June 6, 2008, pp. 1–4. 2 “Cisco Customer Profile: Procter & Gamble,” http://www.cisco.com, accessed July 23, 2002, pp. 1–3. 3 Ibid., p. 3. 4 Anne Millen Porter, “Containing Total Spend,” Purchasing 132 (November 6, 2008): pp. 18–25. Chapter 2 The Business Market: Perspectives on the Organizational Buyer 35 Distribution by Size A startling fact about the study of manufacturers is that so few of them remain. Available evidence suggests that there are approximately 350,000 manufacturing firms in the United States.5 And although only 30,000 manufacturing firms (fewer than 10 percent) employ more than 100 workers each, this handful of firms ships more than 75 percent of all U.S. manufactured products. Because manufacturing operations are so concentrated in the United States, the business marketer normally serves far fewer but far larger customers than does a consumer-product marketer. For example, Intel sells microprocessors to a few large manufacturers, like Dell and Hewlett-Packard, who, in turn, target millions of potential computer buyers. Clearly, large buyers are generally vitally important to business marketers. Because each large firm has such vast buying power, business marketers often tailor particular marketing strategies for each customer. Smaller manufacturing firms also constitute an important business market segment. In fact, more than two-thirds of all U.S. manufacturers employ fewer than 20 people.6 In addition to small manufacturers, more than 5 million small businesses in the United States employ fewer than 6 people each. Based on sheer numbers, small businesses represent a dominant category of business market customers—but a market that is often difficult to serve.7 Because the organizational buyer in smaller firms has different needs—and often a very different orientation—astute marketers adjust their marketing programs to this market segment’s particular needs. To illustrate, FedEx wanted to increase its share of the small shipper market but recognized that picking up packages at many small businesses is more expensive than picking them up at one larger location.8 To cost-effectively reach these customers, FedEx encourages small shippers to bring their packages to conveniently located FedEx drop-off points. The strategy has been successful. Geographical Concentration Size is not the only concentration factor important to the business marketer: Manufacturers are also concentrated geographically. More than half of all U.S. manufacturers are located in only eight states: California, New York, Ohio, Illinois, Michigan, Texas, Pennsylvania, and New Jersey. Most large metropolitan areas are lucrative business markets. Geographical concentration of industry, however, means only that a large potential volume exists in a given area; each buyer’s requirements may still vary significantly. Geographic concentration has important implications for formulating marketing strategy. First, firms can concentrate their marketing efforts in high-market-potential areas, making effective use of full-time personal sales forces in these markets. Second, distribution centers in large-volume areas can ensure rapid delivery to a large proportion of customers. Finally, firms may not be able to tie their salespeople to specific 5 U.S. Department of Commerce, Bureau of the Census, 2005 County Business Patterns, accessed at www.censtats.gov, June 6, 2008. 6 Ibid. 7 Arun Sharma, R. Krishnan, and Dhruv Grewal, “Value Creation in Business Markets,” Industrial Marketing Management 30 (June 2001): pp. 391–402. 8 Thomas H. Davenport, Jeanne G. Harris, and Ajay K. Kohli, “How Do They Know Their Customers So Well?” MIT Sloan Management Review 42 (Winter 2001): p. 65. 36 Part I The Environment of Business Marketing geographic areas because many large buying organizations entrust the responsibility for purchasing certain products and materials for the entire company to a single individual. For example, Wendy’s International, Inc., operates a centralized purchasing system from its Dublin, Ohio, headquarters that supports the entire Wendy’s network—all corporate and franchise restaurants on a global basis. The centralized staff purchases all direct materials for all of the restaurants—food, packaging, and supplies. Judith Hollis, vice president of supply chain management at Wendy’s, notes: We view our job as developing supplier partnerships that are going to assist Wendy’s with maintaining our competitive advantage. We look to . . . companies that are involved in technological innovation in quality, food, safety, and preparation efficiency.9 By understanding how a potential buyer’s purchasing organization is structured, business marketers are better equipped to identify buying influentials and to develop responsive strategy. Classifying Commercial Enterprises Marketers can gain valuable strategy insights by identifying the needs and requirements of different types of commercial enterprises or business customers. The North American Industrial Classification System (NAICS) organizes business activity into meaningful economic sectors and identifies groups of business firms that use similar production processes.10 The NAICS is an outgrowth of the North American Free Trade Agreement (NAFTA); it provides for standard economic data reporting among Canada, Mexico, and the United States. Every plant or business establishment receives a code that reflects the primary product produced at that location. The new system, which includes traditional industries while incorporating new and emergingtechnology industries, replaces the Standard Industrial Classification (SIC) system that was used for decades. Figure 2.1 illustrates the building blocks of the system. Observe that the first two digits identify the economic sector and that as more digits are added, the classification becomes finer. For example, all business establishments that create, disseminate, or provide the means to distribute information are included in the Information sector: NAICS Code 51. Nineteen other economic sectors are included in the system. More specifically, U.S. establishments that produce paging equipment are assigned an NAICS Code of 513321. Individual countries customize the six-digit codes for industry subdivisions, but at the five-digit level they are standardized across the three countries. Using the NAICS If marketing managers understand the needs and requirements of a few firms within a classification category, they can project requirements for other firms that share that category. Each group should be relatively homogeneous in terms of raw materials required, component parts used, and manufacturing processes employed. The NAICS provides a valuable tool for identifying new customers and for targeting profitable segments of business buyers. 9 Michael Fredette, “An Interview with Judith Hollis,” Journal of Supply Chain Management 37 (Summer 2001): p. 3. 10 www.naics.com, “History of SIC/NAICS,” accessed June 15, 2005. Chapter 2 FIGURE 2.1 Economic Sector 2-digit NAICS 51 Information The Business Market: Perspectives on the Organizational Buyer 37 NORTH AMERICAN INDUSTRIAL CLASSIFICATION SYSTEM Economic Subsector 3-digit NAICS 513 Broadcasting and Telecommunications Industry Group 4-digit NAICS 5133 Telecommunications Industry Group 5-digit NAICS 51332 Wireless Telecommunications Carriers U.S. Industry 6-digit NAICS 513321 Paging SOURCE: Reprinted from K. Douglas Hoffman et al., Marketing: Best Practices (Mason, Ohio: South-Western/Thomson Learning, 2003), p. 171. The Purchasing Organization Regardless of its organizational characteristics, every firm must procure the materials, supplies, equipment, and services it needs to operate the business successfully. “Spending on purchased goods and services can represent 70 percent of a company’s costs, so business leaders have long known that purchasing improvements can directly improve the bottom line.”11 How goods and services are purchased depends on such factors as the nature of the business, the size of the firm, and the volume, variety, and technical complexity of items purchased. Rarely do individual departments in a corporation do their own buying. An individual whose title is director of purchasing or director of procurement usually administers procurement for all departments. Indeed, a decade marked by fierce global competition and rising energy and commodity costs opened the eyes of executives everywhere to the strategic benefits that can be achieved through a best-in-class purchasing and supply management function. So the stature and visibility of corporate buyers has risen in the organization. Alcoa Inc., IBM, and Sarah Lee Corporation, along with a growing list of others, have created chief purchasing officer (CPO) positions, often reporting directly to the chief executive or chief operating officer.12 The day-to-day purchasing function is carried out by buyers, each of whom is responsible for a specific group of products. Organizing the purchasing function in this way permits buyers to acquire a high level of technical expertise about a limited number of items. As products and materials become more sophisticated, buyers must 11 Chip W. Hardt, Nicholas Reinecke, and Peter Spiller, “Inventing the 21st Century Purchasing Organization,” The McKinsey Quarterly, 2007 (4): p. 116. 12 Timothy Aeppel, “Global Scramble for Goods Gives Corporate Buyers a Lift,” The Wall Street Journal, October 2, 2007, p. A1; and Shelby D. Hunt and Donna Davis, “Grounding Supply Chain Management in Resource-Advantage Theory,” Journal of Supply Chain Management 44 (January 2008): pp. 10–21. 38 Part I The Environment of Business Marketing TABLE 2.1 THE GOALS OF PURCHASING Goals Description Uninterrupted Flow of Materials Provide an uninterrupted flow of the materials, supplies, and services required to operate the organization. Minimize the investment in inventory. Maintain and improve quality by carefully evaluating and choosing products and services. Find competent suppliers and forge collaborative relationships with supply chain. Purchase required products and services at lowest total cost. Accomplish the purchasing objectives at the lowest possible level of administrative costs. Improve the firm’s competitive position by reducing supply chain costs or capitalizing on the capabilities of suppliers. Manage Inventory Improve Quality Developing and Managing Supplier Relationships Achieve Lowest Total Cost Reduce Administrative Costs Advance Firm’s Competitive Position SOURCE: Adapted with modifications from Michael R. Leenders, Harold E. Fearon, Anna E. Flynn, and P. Fraser Johnson, Purchasing and Supply Management, 12th ed. (Chicago: Irwin, 2002), pp. 40–43, and Andrew Bartolini, “CPO Rising: The CPO’s Agenda for 2008,” Aberdeen Group, February 2008, accessed at http://www.aberdeen .com on June 7, 2008. become more knowledgeable about material characteristics, manufacturing processes, and design specifications. Frequently, a sizable group is employed to conduct research, evaluate materials, and perform cost studies. Goals of the Purchasing Function To address the needs of business customers of all types, the marketer has to understand the purchasing manager’s goals and how the purchasing function contributes to the organization’s objectives (Table 2.1). The purchasing decision maker must juggle a number of different objectives that often clash. For example, the lowest-priced component part is unacceptable if it does not meet quality standards or is delivered two weeks late. In addition to protecting the cost structure of the firm, improving quality, and keeping inventory investment to a minimum, purchasing assumes a central role in managing relationships with suppliers. Here purchasing assumes a central role in supply chain management. Supply chain management is a technique for linking a manufacturer’s operations with those of all of its strategic suppliers, key intermediaries, and customers. The approach seeks to integrate the relationships and operations of both immediate, first-tier suppliers and those several tiers back in the supply chain, in order to help second-, third-, and fourth-tier suppliers meet requirements like quality, delivery, and the timely exchange of information. Firms that embrace supply chain management also solicit ideas from key suppliers and involve them directly in the new-product-development process. By managing supply chain costs and linking supplier capabilities to new product development, the purchasing function is advancing corporate performance in many organizations. Chapter 2 The Business Market: Perspectives on the Organizational Buyer 39 INSIDE BUSINESS MARKETING The Supply Chain for McNuggets Purchasing managers at McDonald’s Corporation have worked closely with suppliers to develop a sophisticated model to reduce the cost of chicken. The model isolates how various feed mixes affect weight gain in chickens, and suppliers are able to optimize chicken weight gain in response to changing food prices. McDonald’s also closely manages and tightly coordinates its supply chain from hatchery to processor and into the restaurants. “McDonald’s explicitly orders hatcheries to place eggs in anticipation of the sales forecast for chicken products. Product movement through the supply base is so well orchestrated that a supplier can confidently place the eggs in the hatcheries seventy-five days before McDonald’s expects to sell the chicken as McNuggets.” SOURCE: Timothy M. Laseter, Balanced Sourcing: Cooperation and Competition in Supplier Relationships (San Francisco: Jossey-Bass, 1998), p. 14. Strategic Procurement13 Leading-edge organizations like Dell Computer, GE, and Honda demonstrate the critical role that purchasing can assume in creating profit opportunities in their industries. To illustrate, Honda, long recognized for purchasing excellence and its ability to sustain customer loyalty, was able to reduce by 20 percent the costs of external purchases that are embodied in the current Accord. A senior purchasing executive at Honda described how it was done: The first thing we did was compile a big list of every possible way we could remove costs from the Accord; most of them, in fact, came from suppliers’ work with purchasing and engineering. We studied each idea, prioritized them according to their likelihood of success, and then just started focusing our work on developing them.14 Understanding the Total Cost To unlock savings and growth opportunities, the purchasing function must develop a keen understanding of the total cost and value of a good or service to the firm. Such an approach requires purchasing managers to consider not only the purchase price but also an array of other considerations: • the factors that drive the cost of the product or service in the supply chain, such as transportation; • the costs of acquiring and managing products or services; • quality, reliability, and other attributes of a product or service over its complete life cycle; • the value of a product or service to a firm and its customers. 13 This section is based on Matthew G. Anderson and Paul B. Katz, “Strategic Sourcing,” International Journal of Logistics Management 9 (1, 1998): pp. 1–13. 14 Timothy M. Laseter, Balanced Sourcing: Cooperation and Competition in Supplier Relationships (San Francisco: Jossey-Bass, 1998), p. 224. 40 Part I The Environment of Business Marketing Fundamental to this total-system cost perspective is the concept of total cost of ownership. “Total cost of ownership considers both supplier and buyer activities, and costs over a product’s or service’s complete life cycle.”15 For example, a firm can justify buying a higher-quality product and paying a premium price because the initial purchase cost will be offset by fewer manufacturing defects, lower inventory requirements, and lower administrative costs. The total cost of ownership means understanding a range of cost-value relationships associated with individual purchases. Levels of Procurement Development In capturing cost savings through improved procurement, Matthew Anderson and Paul Katz of Mercer Management Consulting suggest that firms operate at different levels of development and emphasize different pathways to cost reduction and revenue enhancement (Figure 2.2). Ranging from the least to the most developed, these approaches include (1) Buy for Less; (2) Buy Better; (3) Consume Better; and (4) Sell Better. Note that the most developed strategy—Sell Better—ties purchasing activities directly to strategy. Here procurement builds supplier relationships that ultimately enhance the growth and the market strength of the organization. Level 1—Leveraged Buy (Buy for Less) Many firms demonstrate Level 1 procurement practices and achieve cost savings by centralizing decision-making authority, which permits the consolidation of volume and by selecting suppliers that provide the best prices and terms. Level 2—Linked Buy (Buy Better) The next level of procurement development is triggered when the procurement organization takes an external view of the supply chain and develops mutually beneficial relationships with suppliers. It achieves cost savings by streamlining the bidding process, optimizing delivery and information flows, and making stable commitments to enable efficient production by suppliers. Incremental cost savings of 5 to 25 percent result from moving from Level 1 to Level 2. Level 3—Value Buy (Consume Better) The goal of Level 3 is to advance the performance of the procurement function by optimizing the life cycle costs and value of products and services. Value analysis, complexity management, and early supplier involvement in product design allow buyers and suppliers to uncover added value. • Value analysis is a method of weighing the comparative value of materials, components, and manufacturing processes from the standpoint of their purpose, relative merit, and cost in order to uncover ways of improving products, lowering costs, or both. For example, Ferro Corporation developed a new coating process that allows Whirlpool to paint a refrigerator cabinet in 10 minutes compared with the old process, which took 3 hours.16 The new process provided significant cost savings for Whirlpool. • Complexity management seeks cost reductions by simplifying the design of products or by using standardized component parts in products and across product lines. Complexity management can also involve the outsourcing of 15 Anderson and Katz, “Strategic Sourcing,” p. 3. See also, James Carbone, “Using TCO to Rate Suppliers,” Purchasing 133 (February 19, 2004): pp. 30–34. 16 Elizabeth Baatz, “How Purchasing Handles Intense Cost Pressure,” Purchasing 127 (October 8, 1999): pp. 61–66. FIGURE 2.2 LEVELS OF PROCUREMENT DEVELOPMENT AND PATHWAYS TO SAVINGS/REVENUE ENHANCEMENT Levels of Procurement Development and Pathways to Savings/Revenue Enhancement Levels of Procurement Development 3. Value Buy: Value Management/Optimization 4. Integrated Sell: Commercial Synergy Leverage Points: • Utilize supplier fixed costs more fully • Exploit competitive supply base structure • Leverage buyer‘s share • Enhanced negotiation and contracting skills • Broader consideration of terms and conditions Leverage Points: • Improved coordination/forecast accuracy and predictability • Optimized logistical flows/value added roles • Streamlined transactional information flow • Elimination of redundant/ non–value-added activities • Improved supplier cost productivity • Commitments to enable supplier investments Leverage Points: • Increased and early supplier involvement in solution design • Reduced complexity/simplified specifications • Increased standardization • Clarified response time objectives • Rationalized requirements • Controlled consumption rates • Performance incentives to achieve total cost productivity Leverage Points: • Integrate multi-company products/services and channel portfolio • Introduce creative risk sharing • Exploit supplier capabilites and potential • Manage complex channel relationships • Cross-utilize infrastructure and operating resources among multiple parties in the value chain IMPACT Buy for Less Buy Better Consume Better Sell Better Pathways to Cost Savings and Revenue Enhancement SOURCE: Reprinted with permission from Matthew G. Anderson and Paul B. Katz, “Strategic Sourcing,” International Journal of Logistics Management 9 (1, 1998): p. 4, Figure 3. Website at http://www.ijlm.org. The Business Market: Perspectives on the Organizational Buyer 2. Linked Buy: Supplier-Buyer Integration/Linked Cost Minimization Chapter 2 1. Leveraged Buy: Volume Consolidation/Supply Base Optimization 41 42 Part I FIGURE 2.3 The Environment of Business Marketing SEGMENTING THE BUY Segmenting the Buy Revenue Impact/ Business Risk How much impact could the purchase have on corporate revenues over time? • Advertising • Telemarketing • Branded finished goods • Critical components • High-technology products and services • Outsourced manufacturing functions • Office supplies • Travel • Materials • Logistics • Benefits programs • Professional services Procurement Complexity Highest Customer Value Impact How complex are the cost drivers of the purchase? • Technology/design • Supply chain integration • Lifecycle management SOURCE: Reprinted with permission from Matthew G. Anderson and Paul B. Katz, “Strategic Sourcing,” International Journal of Logistics Management 9 (1, 1998): p. 7, Figure 8. Website at http://www.ijlm.org. production or assembly tasks to supply chain partners. For example, Boeing is taking the concept of supplier collaboration to new heights in the development of the 787 Dreamliner. Rather than integrating supplier parts and materials in its own features, key suppliers assume that responsibility and provide complete subsystems to Boeing. To illustrate, Rockwell Collins provides the major avionics systems—displays, communications, and more—to Boeing for the 787.17 • To capture fresh ideas, technologies, and cost savings, leading purchasing organizations emphasize early supplier involvement in new product development. At firms like Boeing, Harley-Davidson, Apple, and Honda, key suppliers actively contribute to the new-product-development process from the design stage to the product’s introduction, often spending months on-site collaborating with the development team. By using these methods, Level 3 savings opportunities can be substantial. Research by McKinsey & Company indicates that high-performing purchasing groups generate annual cost savings that are nearly six times greater than those of low performers.18 Level 4—Integrated Sell (Sell Better) Level 4 development applies when specific product and service choices the purchasing organization makes have a significant effect on revenue and also involve a high degree of business risk. For example, the investments of a telecommunications firm such as AT&T in technology products that form its infrastructure have a major effect on the future of the firm. Under such 17 Susan Avery, “Boeing Executive Steven Schaffer is Named Supply Chain Manager of the Year for the 787 Dreamliner Project,” October 18, 2007 Issue of Purchasing, accessed at http://www.purchasing.com on June 5, 2008. 18 Hardt, Reinecke, and Spiller, “Inventing the 21st Century Purchasing Organization,” p. 116. Chapter 2 The Business Market: Perspectives on the Organizational Buyer 43 INSIDE BUSINESS MARKETING Respond with Value-Based Selling Tools Astute B2B marketing strategists use value-based selling to vividly demonstrate the superior value that they provide compared to rivals. For example, Microsoft provides an online tool that potential business customers can use to cost, configure, and compare the Microsoft Windows Server to the whole universe of options, such as Linux. In 5 minutes or less, a business customer can estimate the total cost of ownership of the Microsoft option and then undertake a more detailed business-value study that provides a comprehensive analysis of costs and benefits—tailored to their organization. To illustrate, when the Linux-based highperformance computing cluster at Callaway Golf reached the end of its useful life, key decision makers decided to examine two options: (1) another Linux-based system or (2) a solution based on Windows Compute Cluster Server running on Hewlett-Packard hardware. Callaway Golf chose the high-performance computing solution based on the Windows server because it offered significant advantages, including manageability, ease of use, and cost. John Loo, design systems senior manager at Callaway Golf, observed: “What really surprised us was the difference in software licensing and maintenance costs. A Linux solution would have been more expensive because we would have needed a separate job scheduler, which is something that Windows Compute Cluster Server provides.” Microsoft used value-based selling to demonstrate the points of difference. SOURCE: “Microsoft Customer Case Study: Callaway Golf,” April 11, 2008, accessed at http://www.microsoft.com on June 12, 2008. conditions, choosing the right technologies and sharing the risks with important suppliers are crucial to the success of AT&T’s corporate strategy. Highly skilled and knowledgeable purchasing professionals are required to achieve this advanced level of procurement development, which unites purchasing decisions with corporate growth strategies. Segmenting Purchase Categories Each firm purchases a unique portfolio of products and services. Leaders in procurement are giving increased attention to segmenting total purchases into distinct categories and sharpening their focus on those purchases that have the greatest effect on revenue generation or present the greatest risk to corporate performance. From Figure 2.3, observe that various categories of purchases are segmented on the basis of procurement complexity and the nature of the effect on corporate performance (that is, revenue impact/business risk). Which Purchases Affect Performance? Procurement complexity considers factors such as the technical complexity, the scope of supply chain coordination required, and the degree to which life cycle costs are relevant. The revenue impact/business risk dimension considers the degree to which a purchase category can influence customers’ perceptions of value. For example, purchasing managers at Ford decided that some components are important to brand identity, such as steering wheels, road wheels, and other highly visual parts. Purchasing managers can use a segmentation approach to isolate those purchase categories that have the greatest effect on corporate revenues. For example, advertising services could have tremendous risk implications relative to customer perceptions of value, whereas office supplies remain a cost issue. Or, in the high-tech arena, the 44 Part I The Environment of Business Marketing procurement of a new generation of semiconductor technology may essentially be a bet on the company’s future.19 Business marketers should assess where their offerings are positioned in the portfolio of purchases a particular organization makes. This varies by firm and by industry. The revenue and profit potential for the business marketer is greatest in those purchasing organizations that view the purchase as strategic—high revenue impact and high customer-value impact. For example, in the auto industry, electronic braking systems, audio and navigation systems, as well as turbochargers, fit into this category and represent about one-quarter of a passenger vehicle’s cost.20 Here the marketer can contribute offerings directly tied to the customer organization’s strategy, enjoying an attractive profit margin. If the business marketer can become a central component of the customer’s supply chain, the effect is even more significant: a valuable, long-term relationship in which the customer views the supplier as an extension of its organization. For categories of goods that purchasing organizations view as less strategic (for example, office supplies), the appropriate marketing strategy centers on providing a complete product assortment, competitive pricing, timely service support, and simplified ordering. By understanding how customers segment their purchases, business marketers are better equipped to target profitable customer groups and develop customized strategies. E-Procurement 21 Like consumers who are shopping at Amazon (http://www.amazon.com), purchasing managers use the Internet to find new suppliers, communicate with current suppliers, or place an order. While providing a rich base of information, purchasing over the Internet is also very efficient: It is estimated that purchase orders processed over the Internet cost only $5, compared with the current average purchase order cost of $100. For example, IBM has moved all of its purchasing to the Web and has created a “private exchange” that links its suppliers. A private exchange allows a company like IBM to automate its purchases and collaborate in real time with a specially invited group of suppliers.22 By handling nearly all its invoices electronically (some 400,000 e-invoices a month), IBM saves nearly $400 million per year using its more efficient Web purchasing strategy. Everyone Is Getting Wired Less than a decade ago, pioneering enterprises like IBM, GE, and United Technologies began testing Internet-based negotiations as part of their strategic purchasing programs. Today, more than 80 percent of Fortune 1000 enterprises have adopted e-procurement software, and new low-cost, hosted options are driving the adoption of e-procurement solutions among medium-sized enterprises. Leading suppliers of 19 Anderson and Katz, “Strategic Sourcing,” p. 7. 20 Srikant Inampudi, Aurobind Satpathy, and Anant Singh, “Can North American Auto Suppliers Create Value?” The McKinsey Quarterly, June 2008, accessed at http://www.mckinsey.com on June 8, 2008. 21 Tim A. Minahan, “Best Practices in E-Sourcing: Optimizing and Sustaining Supply Savings,” September 2004, research report by Aberdeen Group, Inc., Boston, Massachusetts; accessed at http://www.ariba.com on June 15, 2005. 22 Nicole Harris, “‘Private Exchanges’ May Allow B-to-B Commerce to Thrive After All,” The Wall Street Journal, March 16, 2001, p. B4. Chapter 2 The Business Market: Perspectives on the Organizational Buyer 45 e-procurement software include Ariba, Inc. (http://www.ariba.com), Emptoris (http:// www.emptoris.com), and Oracle Corporation (http://www.oracle.com). To compete effectively in this information-rich environment, business marketing managers must develop a firm understanding of the e-procurement tools that customers are embracing. Enhancing the Buyer’s Capabilities Rather than a strategy, e-procurement is a technology platform that enables information to be exchanged efficiently and processes to be automated. E-procurement is “the use of Web-based applications, decision support tools, and associated services to streamline and enhance strategic sourcing processes and knowledge management.”23 Included among the distinguishing components of e-procurement solutions are the following capabilities: • online negotiations that enable the buyer to query suppliers with a request-forproposal (RFP), request-for-quote (RFQ), or request-for-information (RFI), and to conduct reverse auctions (discussed below); • collaboration tools that enable the purchasing manager to (1) collaborate with internal stakeholders (for example, departments) to develop detailed specifications and priorities for goods or services to be purchased and (2) provide a detailed description of requirements to suppliers through an RFP; • knowledge management capabilities that provide the procurement function and senior management with a central repository of valuable data and information on supplier performance, material and component costs, process flows, and best practices; • analytical tools that support detailed analysis and modeling of purchasing costs and total spending by category across the enterprise. Delivering Measurable Results Why are purchasing organizations embracing online purchasing technologies? Because they “deliver measurable benefits in the form of material cost savings, process efficiencies, and performance enhancements” according to Tim Minahan, a supply chain consultant at the Aberdeen Group.24 Studying procurement processes at sixty companies, including American Express, Motorola, and Alcoa, Aberdeen found that e-procurement cut purchasing cycle time in half, reduced material costs by 14 percent and purchasing administrative costs by 60 percent, and enhanced the ability of procurement units to identify new suppliers on a global scale. Buying Direct and Indirect Goods In the United States alone, organizations spend more than $1.4 trillion annually on indirect goods or operating resources—items that organizations of all types need to run day-to-day operations. Examples encompass everything from personal computers 23 Minahan, “Best Practices in E-Sourcing,” p. 3. 24 Ibid., p. 3. 46 Part I The Environment of Business Marketing and spare parts for factory equipment to office furniture and employee travel, including airline tickets, hotel rooms, and car rental services.25 Powered by software from Ariba, Motorola has used its global e-requisitioning system to reduce procurement costs and control indirect purchasing, yielding more than $300 million of cost savings in a recent year.26 During the Internet-boom years, companies invested heavily in e-procurement systems but used them primarily to buy indirect goods. As adopters reaped huge cost savings and began to trust Internet-based purchasing systems, many firms began to use e-procurement to buy direct materials or entering goods—the raw materials or component parts that are core to a firm’s manufacturing process. As e-procurement systems become more affordable, some experts predict that small and medium-sized firms will soon adopt the purchasing practices of the industry leaders. To illustrate, many suppliers apply what they learn from best-practice firms, like Toyota, to their own purchasing processes and relationship management programs. Reverse Auctions One online procurement tool that sparks debate in the business market is the reverse auction. Rather than one seller and many buyers, a reverse auction involves one buyer who invites bids from several prequalified suppliers who face off in a dynamic, real-time, competitive bidding process. Reverse auctions are most widely used in the automobile, electronics, aerospace, and pharmaceutical industries. Proponents claim that reverse auctions can lower the cost of procuring products and services by 20 percent or more. A case in point: Sun MicroSystems saved 30 percent on the commodities it purchased through reverse auctions.27 Critics counter that reverse auctions can inflict real damage on supplier relationships and that the realized savings are often overstated.28 For example, during the recent economic downturn, many firms used reverse auctions as a tactical weapon to drive supplier prices down but often found that the winning bidder delivered less value—lower quality and poorer service than existing suppliers. Reverse auctions are best suited for commodity-type items like purchasing materials, diesel fuel, metal parts, chemicals, and many raw materials. On the other hand, reverse auctions are generally not appropriate for strategic relationships, where suppliers have specialized capabilities and few suppliers can meet quality and performance standards. Rob Harlan, senior director of e-procurement for Motorola, aptly states: “We pride ourselves on strong supplier relationships. We are not going to jeopardize these for short-term gains with online auctions. You need to ensure the integrity of the bidding environment, educate suppliers on how best to compete, and clearly communicate your intentions and requirements.”29 25 Mark Vigoroso, “Buyers Prepare for Brave New World of e-Commerce,” Purchasing 127 (April 22, 1999): pp. S4–S12; and Mylene Mangalindan, “As Times Get Tough, Firms Buy Online,” The Wall Street Journal, June 3, 2008, p. B10. 26 James Carbone, “Motorola Leverages Its Way to Lower Cost,” Purchasing 133 (September 16, 2004): pp. 31–38. 27 James Carbone, “Sun’s e-Auction Evolution,” September 13, 2007 issue of Purchasing, accessed at http://www .purchasing.com on June 10, 2008. 28 Mohanbir Sawhney, “Forward Thinking About Reverse Auctions,” June 1, 2003 issue of CIO Magazine, accessed at http://www.cio.com on June 20, 2005, pp. 1–6. 29 Minahan, “Best Practices in E-Sourcing,” p. 52. Chapter 2 The Business Market: Perspectives on the Organizational Buyer 47 ETHICAL BUSINESS MARKETING Gift Giving: “Buy Me These Boots and You’ll Get My Business” Greg Davies, director of sales for Action Printing in Fond du Lac, Wisconsin, encountered this awkward situation. Leaving a restaurant after taking a potential customer to lunch, the prospective client stopped to examine the window display of a country-and-western store located nearby. That’s when Davies’s prospect turned to him and said very slowly: “I have always wanted a pair of boots like this.” “There was no mistaking it: He expected me to buy him the boots,” recalls Davies, who simply smiled and began walking again. He declined because company policy, as well as his personal value system, forbids the exchange of expensive personal gifts for business. As you would imagine, from that day forward, Greg felt awkward around the prospect. Sales experts suggest that Greg made the right business decision, as well as the right moral decision. He stood behind a well-conceived company policy. In turn, Jacques Werth, a sales consultant, agreed with the decision to walk away. “If your relationship is based on extravagant gifts, entertainment, and other perks, you’re likely to lose the business when a bigger bribe comes along, anyway.” SOURCE: Melinda Ligos, “Gimme, Gimme, Gimme!” Sales & Marketing Management (March 2002): pp. 33–40. How Organizational Buyers Evaluate Potential Suppliers E-procurement systems provide purchasing managers with a rich information environment and a sophisticated set of analytical tools they can use to evaluate the performance of suppliers. Many criteria may be factored into a buyer’s ultimate decision: quality, price, delivery reliability, company image, and capability. Buyer perceptions are critical. When products are perceived as highly standardized or commodity-like, price assumes special importance in the purchasing decision and the business marketer faces the intense competitive pressure that reverse auctions impose. On the other hand, when the value offerings of the business marketer are perceived as unique, other criteria dominate and the opportunity exists to develop a strategic relationship with the customer. At a fundamental level, customers in the business market are interested in the total capabilities of a supplier and how those capabilities can assist them in advancing their competitive position—now and in the future. To this point, the discussion has centered on one sector of the business market— commercial enterprises—and the role the purchasing function assumes. Attention now turns to the government market. Governments: Unique Characteristics Federal (1), state (50), and local (87,000) government units generate the greatest volume of purchases of any customer category in the United States. Collectively, these units spend more than $1.5 trillion on goods and services each year—the federal government accounts for $400 billion, and states and local government account for the rest.30 Governmental units purchase from virtually every category of goods 30 U.S. Census Bureau, Statistical Abstract of the United States: 2008, accessed at http://www.census.gov on June 12, 2008. 48 Part I The Environment of Business Marketing FIGURE 2.4 HEWLETT PACKARD’S E-GOVERNMENT STRATEGY As customers have become adept at shopping online, managing their bank accounts, and requesting services, Internet-savvy citizens now expect the same from their governments. Enabled by information technology, public agencies are giving citizens new tools to access information and services while, at the same time, introducing new efficiencies in government operations. Hewlett Packard (H-P) has developed a complete portfolio of services tailored to e-government goals: • Improving quality and ease of access for citizens • Reducing the cost of service delivery • Simplifying the implementation of government directives • Advancing economic growth by stimulating the development of a digital economy H-P offers targeted solutions that allow citizens to: • Test for and renew drivers’ licenses online • Purchase decals and permits online • Access information and services around the clock from public agencies and government departments H-P has also developed a suite of solutions that governments require for efficient and effective Homeland Security. Included here are: • Mission-focused technology solutions that protect borders and public transportation systems • Supportive technologies to enhance the capabilities of law enforcement agencies, firefighters, and emergency response teams • Security solutions to protect critical infrastructure assets and defend against catastrophic threats. H-P Success Story: • Government Customer: Chicago Office of Emergency and Communications (OEMC) • Mission: The Chicago OEMC is responsible for all 911 communications and emergency operations and for responding to emergency incidents of all types in the city. • Customer Solution: H-P technologies were applied to support an integrated emergency operation center and are deployed in a Unified Communications Vehicle, which enables city personnel to continue operations from any location. The OEMC also uses surveillance cameras to increase situational awareness when responding to 911 calls. • Results: The Chicago city government can sustain operations in an alternate location in the event that activities at any of its government buildings are disrupted. SOURCES: “HP Services: A Comprehensive Managed Services Portfolio,” “Homeland Security,” and “Public Sector, Health, and Education,” accessed at http://www.hp.com on December 4, 2008 and “Securing a City: Chicago Takes a Unified Approach to Emergency Management,” accessed at http://www.hp.com on December 26, 2008. Chapter 2 The Business Market: Perspectives on the Organizational Buyer 49 and services—office supplies, personal computers, furniture, food, health care, and military equipment. Business marketing firms, large and small, serve the government market. In fact, 25 percent of the purchase contracts at the federal level are with small firms.31 E-Government Across all levels of government, public officials are embracing the Internet as the best means of delivering services to constituents. E-government, then, involves transferring traditional government operations to an integrated Internet environment to improve public-sector accessibility, efficiency, and customer service. For example, www. govbenefits.com now provides users with access to information about 200 special government benefit programs, and www.recreation.gov provides a description of all publicly managed recreation sites in the United States. Many states, such as Texas, Arizona, Michigan, and Illinois, are launching creative e-government initiatives to deliver service to citizens. For business marketing firms like IBM and Hewlett-Packard that sell information technology products and services, e-government initiatives are sparking a large market opportunity (see Figure 2.4). Influences on Government Buying Another level of complexity is added to the governmental purchasing process by the array of influences on this process. In federal, state, and large-city procurement, buyers report to and are influenced by dozens of interested parties who specify, legislate, evaluate, and use the goods and services. Clearly, the range of outside influences extends far beyond the originating agency. Understanding Government Contracts Government purchasing is also affected by goals and programs that have broad social overtones, including compliance, set-asides, and minority subcontracting. The compliance program requires government contractors to maintain affirmative action programs for minorities, women, and the handicapped. Firms failing to do so are barred from holding government contracts. In the set-aside program, a certain percentage of a given government contract is “set aside” for small or minority businesses; no others can participate in that proportion of the contract. The minority subcontracting program may require that major contractors subcontract a certain percentage of the total contract to minority firms. For example, Ohio law requires that 7 percent of all subcontractors on state construction projects be minorities. The potential government contractor must understand these programs and how they apply to the firm. Most government procurement, at any level, is based on laws that establish contractual guidelines.32 The federal government has set forth certain general contract provisions as part of the federal procurement regulations. These provisions include stipulations regarding product inspection, payment methods, actions as a result of default, and disputes, among many others. 31 Stephanie N. Mehta, “Small Firms Are Getting More Government Contracts,” The Wall Street Journal, April 27, 1995, p. B2. 32 Michael R. Leenders and Harold E. Fearon, Purchasing and Supply Management, 11th ed. (Chicago: Irwin, 1997), pp. 537–566. 50 Part I The Environment of Business Marketing Without a clear comprehension of the procurement laws, the vendor is in an unfavorable position during the negotiation phase. The vendor particularly needs to explore the advantages and disadvantages of the two basic types of contracts: 1. Fixed-price contracts. A firm price is agreed to before the contract is awarded, and full payment is made when the product or service is delivered as agreed. 2. Cost-reimbursement contracts. The vendor is reimbursed for allowable costs incurred in performance of the contract and is sometimes allowed a certain number of dollars above cost as profit. Each type of contract has built-in incentives to control costs or to cover future contingencies. Generally, the fixed-price contract provides the greatest profit potential, but it also poses greater risks if unforeseen expenses are incurred, if inflation increases dramatically, or if conditions change. However, if the seller can reduce costs significantly during the contract, profits may exceed those estimated when the contract was negotiated. The government carefully administers cost-reimbursement contracts because of the minimal incentives for contractor efficiency. Contracts of this type are usually employed for government projects involving considerable developmental work for which it is difficult to estimate efforts and expenses. To overcome the inefficiencies of both the cost-reimbursement contract (which often leads to cost overruns) and the fixed-price contract (which can discourage firms from bidding because project costs are uncertain), the government often employs incentive contracts. The incentive contract rewards firms when their actual costs on a project are below target costs, and it imposes a penalty when they exceed target costs. Telling Vendors How to Sell: Useful Publications Unlike most customers, governments often go to great lengths to explain to potential vendors exactly how to do business with them. For example, the federal government makes available such publications as Doing Business with the General Services Administration, Selling to the Military, and Selling to the U.S. Air Force. Government agencies also hold periodic seminars to orient businesses to the buying procedures the agency uses. The objective is to encourage firms to seek government business. Purchasing Organizations and Procedures: Government Government and commercial purchasing are organized similarly. However, governments tend to emphasize clerical functions because of the detailed procedures the law requires. Although the federal government is the largest single industrial purchaser, it does not operate like a single company but like a combination of several large companies with overlapping responsibilities and thousands of small independent units.33 The federal government has more than 15,000 purchasing authorities (departments, agencies, and so on). Every government agency possesses some degree of buying influence or authority. Federal government procurement is divided into two categories: defense and nondefense. 33 Ibid., pp. 552–559. Chapter 2 The Business Market: Perspectives on the Organizational Buyer 51 Defense Procurement The Department of Defense (DOD) spends a large proportion of the federal government’s total procurement budget. The DOD’s procurement operation is said to be the largest business enterprise in the world. The era of declining budgets for the DOD was quickly reversed with the terrorist attacks on the United States in September 2001. Defense and homeland security became funding priorities in the federal budget. Each DOD military division—Army, Navy, and Air Force—is responsible for its own major purchases. However, the Defense Logistics Agency (DLA) procures billions of dollars worth of supplies used in common by all branches. The DLA’s budget for procurement exceeds $35 billion annually.34 The purposes of the DLA are to obtain favorable prices through volume purchasing and to reduce duplication of purchasing within the military. Defense-related items may also be procured by other government agencies, such as the General Services Administration (GSA). In fact, the DOD is the GSA’s largest customer. Under current agreements between the GSA and the DOD, the military purchases through the GSA many items such as vehicles, desks, office machines, and hand tools.35 Also, many supplies for military-base operations are procured locally. Nondefense Procurement Nondefense procurement is administered by a wide variety of agencies, including cabinet departments (for example, Health and Human Services, Commerce), commissions (for example, the Federal Trade Commission), the executive branch (for example, the Bureau of the Budget), federal agencies (for example, the Federal Aviation Agency), and federal administrations (for example, the GSA). The Department of Commerce centralizes the procurement of supplies and equipment for its Washington office and all local offices. The Department of the Interior, on the other hand, instructs each area and district office of the Mining Enforcement and Safety Administration to purchase mine-safety equipment and clothing locally. Like the DLA, the GSA centralizes the procurement of many general-use items (for example, office furniture, pens, lightbulbs) for all civilian government agencies. The Federal Supply Service of the GSA is like the purchasing department of a large diversified corporation because it provides a consolidated purchasing, storing, and distribution network for the federal government. The Federal Supply Service purchases many items commonly used by other government agencies, including office supplies, small tools, paint, paper, furniture, maintenance supplies, and duplicating equipment. In some cases, the GSA operates retail-like stores, where any federal buyer can go to purchase equipment and supplies. The GSA has enormous purchasing power, managing more than one-fourth of the government’s total procurement dollars.36 Under the Federal Supply Schedule Program, departments within the government may purchase specified items from an approved supplier at an agreed-on price. This program provides federal agencies with the sources of products such as furniture, appliances, office equipment, laboratory equipment, and the like. Once a supplier has bid and been approved, the schedule may involve an indefinite-quantity contract for a 34 Defense Logistics Agency, “Facts and Figures,” accessed at http://www.dla.mil on June 10, 2008. 35 U.S. General Services Administration, “Doing Business with the GSA” (Washington, D.C., 1996). 36 U.S. General Services Administration, “GSA Details FY09 Budget Request,” accessed at 10, 2008. http://www.gsa.gov on June 52 Part I The Environment of Business Marketing term of 1 to 3 years. The schedule permits agencies to place orders directly with suppliers. Like corporate purchasing units, the GSA is using the Internet to streamline purchasing processes and to facilitate communication with suppliers (see http://www .gsa.gov). Federal Buying The president may set the procurement process in motion when he signs a congressional appropriation bill, or an accountant in the General Accounting Office may initiate the process by requesting a new desktop computer. Business marketers can identify the current needs of government buyers by consulting FedBizOpps ( FBO) at http://www.fbodaily.com. The FBO, published by the Department of Commerce, lists all government procurement proposals, subcontracting leads, contract awards, and sales of surplus property. A potential supplier has at least 30 days to respond before bid opening. By law, all intended procurement actions of $10,000 or more, both civilian and military, are published in the FBO. Copies of the FBO are available at various government field offices, as well as local public libraries. Once a procurement need is documented and publicly announced, the government follows one of two general procurement strategies: formal advertising (also known as open bid) or negotiated contract. Formal Advertising Formal advertising means the government solicits bids from appropriate suppliers; usually, the lowest bidder is awarded the contract. This strategy is followed when the product is standardized and the specifications straightforward. The interested supplier must gain a place on a bidder’s list (or monitor the FBO on a daily basis—which suggests that a more effective approach is to get on the bidder’s list by filing forms available from the GSA Business Service Centers). Then, each time the government requests bids for a particular product, the supplier receives an invitation to bid. The invitation to bid specifies the item and the quantity to be purchased, provides detailed technical specifications, and stipulates delivery schedules, warranties required, packing requirements, and other purchasing details. The bidding firm bases its bid on its own cost structure and on the bids it believes its competitors might make. Procurement personnel review each bid for conformance to specifications. Contracts are generally awarded to the lowest bidder; however, the government agency may select the next-to-lowest bidder if it can document that the lowest bidder would not responsibly fulfill the contract. For example, the Internal Revenue Service (IRS) held a reverse auction for 11,000 desktop PCs and 16,000 notebook PCs. The prebid pricing started at $130 million; when the auction closed, the price was down to $63.4 million.37 Negotiated Contract Buying A negotiated contract is used to purchase products and services that cannot be differentiated on the basis of price alone (such as complex scientific equipment or R&D projects) or when there are few suppliers. There may be some competition because the contracting office can conduct negotiations with several suppliers simultaneously. 37 Richard Walker and Kevin McCaney, “Reverse Auctions Win Bid of Acceptance,” Buyers.Gov (December 2001): p. 1. Chapter 2 The Business Market: Perspectives on the Organizational Buyer 53 Obviously, negotiation is a much more flexible procurement procedure; the government buyers may exercise considerable personal judgment. Procurement is based on the more subjective factors of performance and quality, as well as on price. The procurement decision for the government is much like that of the large corporation: Which is the best possible product at the lowest price, and will the product meet performance standards? For example, the U.S. Army and Marines are together planning to replace the Humvee transports used in Iraq with a Joint Light Tactical Vehicle.38 Lockheed Martin Corporation and Boeing Company, the two largest U.S. defense contractors, are each competing for the contract, along with a formidable set of rival teams led by General Dynamics Corporation, BAE Systems, Northrop Grumman Corporation, and Raytheon Company, respectively. From this field of competitors, three development contracts will be awarded first. That will set the stage for a competition in 2011 where each of the three rivals will demonstrate the performance and reliability of its vehicle. The stakes are high: The winner will receive a $40 billion order to supply 60,000 vehicles over the next decade. A Different Strategy Required A marketer positioned to sell to the government has a much different marketing strategy focus than does a firm that concentrates on the commercial sector. The government seller emphasizes (1) understanding the complex rules and standards that must be met; (2) developing a system to keep informed of each agency’s procurement plans; (3) generating a strategy for product development and R&D that facilitates the firm’s response to government product needs; (4) developing a communications strategy that focuses on how technology meets agency objectives; and (5) generating a negotiation strategy to secure favorable terms regarding payment, contract completion, and cost overruns due to changes in product specifications. The Institutional Market: Unique Characteristics Institutional customers comprise the third sector of the business market. Institutional buyers make up a sizable market—total expenditures on public elementary and secondary schools alone exceed $500 billion, and national health expenditures exceed $1.9 trillion.39 Schools and health-care organizations make up a sizable component of the institutional market, which also includes colleges and universities, libraries, foundations, art galleries, and clinics. On the one hand, institutional purchasers are similar to governments in that the purchasing process is often constrained by political considerations and dictated by law. In fact, many institutions are administered by government units—schools, for example. On the other hand, other institutions are privately operated and managed like corporations; they may even have a broader range of purchase requirements than their large corporate counterparts. Like the commercial enterprise, institutions are ever cognizant of the value of efficient purchasing. 38 Edmond Lococo, “Lockheed, Boeing Brains Fizzle in Humvee-Heir Bid (Updated),” Bloomberg.com June 4, 2008, accessed at http://www.bloomberg.com on June 5, 2008. 39 U.S. Census Bureau, Statistical Abstract of the United States: 2008, accessed at http://www.census.gov on June 12, 2008. 54 Part I The Environment of Business Marketing Institutional Buyers: Purchasing Procedures Diversity is the key element in the institutional market. For example, the institutional marketing manager must first be ready to respond to a school purchasing agent who buys in great quantity for an entire city’s school system through a formal bidding procedure and then respond to a former pharmacist who has been elevated to purchasing agent for a small rural hospital. Health-care institutions provide a good example of the diversity of this market. Some small hospitals delegate responsibility for food purchasing to the chief dietitian. Although many of these hospitals have purchasing agents, the agent cannot place an order unless the dietitian approves it. In larger hospitals, decisions may be made by committees composed of a business manager, purchasing agent, dietitian, and cook. In still other cases, hospitals may belong to buying groups consisting of many local hospitals or meal preparation may be contracted out. In an effort to contain costs, purchasing executives at large hospitals are adopting a supply chain focus and using sophisticated supplier evaluation methods, including e-procurement tools, like their counterparts in the commercial sector. Because of these varied purchasing environments, successful marketers usually maintain a separate marketing manager, staff, and sales force to tailor marketing efforts to each situation. For many institutions, once a department’s budget has been established, the department attempts to spend up to that budget limit. So, institutions may buy simply because there are unused funds in the budget. A business marketer should carefully evaluate the budgetary status of potential customers in the institutional segment of the market. Because many institutions face strong budgetary pressures, they often outsource segments of their operations to specialists to enhance efficiency and effectiveness. School districts may look to third-party contractors to purchase food and supplies and to manage their meal service operations. For example, in Los Angeles, Marriott Corporation manages food service operations at the city’s charter schools, and in Chicago, three different contract companies each operate 10 food-preparation departments.40 Many universities have turned over operation of their bookstores and beverage contracts and management of their student unions to outside contractors. Business marketers must carefully analyze and understand the operational strategy of their institutional customers. Frequently, extensive sales and marketing attention must center on the third-party contract operators. Targeted Strategy The institutional market offers some unique applications for the concept of multiple buying influences (discussed in Chapter 1). Many institutions are staffed with professionals—doctors, professors, researchers, and others. In most cases, depending on size, the institution employs a purchasing agent and, in large institutions, a sizable and skilled purchasing department or materials management department. There is great potential for conflict between those responsible for purchasing and the professional staff for whom the purchasing department is buying. Often, the salesperson must carefully cultivate the professional staff in terms of product benefits and service while developing a delivery timetable, maintenance contract, and price schedule to satisfy the purchasing department. Leading business marketers also use the Internet to provide added value to 40 Susie Stephenson, “Schools,” Restaurants and Institutions 106 (August 1, 1996): pp. 60–64. Chapter 2 FIGURE 2.5 The Business Market: Perspectives on the Organizational Buyer 55 GE HEALTHCARE RE-IMAGINED ADVERTISING: HOW DO YOU CAPTURE A STILL IMAGE OF SOMETHING THAT NEVER SITS STILL? SOURCE: © 2008 General Electric Company. All rights reserved. Reprinted by permission from General Electric Company. Accessed at http://www.ge.com/company/advertising/ads_healthcare.html. their customers. For example, GE Healthcare, a leader in medical imaging and diagnostics equipment (see Figure 2.5), has embraced e-commerce as the centerpiece of its marketing strategy and provides an online catalog, daily Internet specials, and a host of services for its customers—purchasing managers at hospitals and health-care facilities worldwide. In fact, GE and the University of Pittsburgh Medical Center have formed a company to move the laboratory analysis of human tissue into the digital age.41 Following a routine that has changed little in the past century, the vast majority of tissue samples are viewed individually by doctors using a microscope. The goal of this new venture is to create and market a “virtual microscope” that would scan and store images electronically, improving patient care by making it easier for doctors to share information. Group Purchasing An important factor in institutional purchasing is group purchasing. Hospitals, schools, and universities may join cooperative purchasing associations to obtain quantity discounts. Universities affiliated with the Education and Institutional Purchasing Cooperative enjoy favorable contracts established by the cooperative and can purchase a wide array of products directly from vendors at the low negotiated prices. The cooperative spends more than $100 million on goods 41 Scott Thurm, “GE Venture to Develop ‘Virtual Microscope’,” The Wall Street Journal, June 5, 2008, p. B5. 56 Part I The Environment of Business Marketing FIGURE 2.6 A MARKET-CENTERED ORGANIZATION Marketing Vice-President Marketing Research Manager Advertising Manager Sales Manager Markets Manager Commercial Market Specialist Government Market Specialist Institutional Market Specialist annually. Cooperative buying allows institutions to enjoy lower prices, improved quality (through improved testing and vendor selection), reduced administrative cost, standardization, better records, and greater competition. Hospital group purchasing represents a significant market exceeding $10 billion. Group purchasing has become widely accepted: More than one-third of public-sector hospitals in the United States are members of some type of affiliated group. Most hospital group purchasing is done at the regional level through hospital associations. However, for-profit hospital chains, which are a growing factor in the health-care field, also engage in group buying. For example, a multihospital system with a $1 billion operating budget spends $300 to $500 million a year on medical supplies and purchased services. By channeling purchases through group purchasing organizations, these large buyers are reaping significant savings.42 Group purchasing poses special challenges for the business marketer. The marketer must develop not only strategies for dealing with individual institutions but also unique strategies for the special requirements of cooperative purchasing groups and large hospital chains. The buying centers—individual institution versus cooperative purchasing group—may vary considerably in composition, criteria, and level of expertise. For the purchasing groups, discount pricing assumes special importance. Suppliers who sell through purchasing groups must also have distribution systems that effectively deliver products to individual group members. And even though vendors have a contract with a large cooperative association, they must still be prepared to respond individually to each institution that places an order against the contract. Institutional Purchasing Practices In many respects the purchasing practices of large institutions are similar to those of large commercial firms, but there are some important differences. The policies regarding cooperative buying, preference for local vendors, and the delegation of purchasing responsibility for food, pharmaceuticals, and many other 42 Timothy L. Chapman, Ajay Gupta, and Paul O. Mange, “Group Purchasing Is Not a Panacea for U.S. Hospitals,” McKinsey Quarterly, no. 1 (1998): p. 160. Chapter 2 The Business Market: Perspectives on the Organizational Buyer 57 items are of particular importance. The business marketer must understand these characteristics to carefully develop effective strategies for these institutional customers. Dealing with Diversity: A Market-Centered Organization Because each sector of the business market is unique, many firms have built market specialization into the marketing organization. To illustrate, the industrial products area of the J. M. Smucker Company is organized around market sectors. The institutional, military, and business markets are each managed by different individuals, each thoroughly knowledgeable about one particular market. Figure 2.6 illustrates one form of a market-centered organizational scheme. Observe that a market manager supervises and coordinates the activities of three market specialists. Each market specialist examines the buying processes, the product preferences, and the similarities and differences between customers in one sector of the business market. Such an analysis enables the market specialist to further categorize customers in a particular sector into meaningful market segments and to design specialized marketing programs for each. A market-centered organization provides the business marketer with a structure for dealing effectively with diversity in the business market. Summary In business-to-business marketing, the customers are organizations. The business market can be divided into three major sectors: commercial enterprises, governments (federal, state, and local), and institutions. Many business marketers—for example, Intel, Boeing, and IBM—generate a significant proportion of their sales and profit by serving international customers. Indeed, the demand for many industrial products is growing more rapidly in many foreign countries than in the United States. Commercial enterprises include manufacturers, construction companies, service firms, transportation companies, selected professional groups, and resellers. Of these, manufacturers account for the largest dollar volume of purchases. Furthermore, although the majority of manufacturing firms are small, buying power is concentrated in the hands of relatively few manufacturers, which are also concentrated geographically. Commercial enterprises, such as service establishments and transportation or utility companies, are more widely dispersed. A purchasing manager or purchasing agent administers the procurement process. In large firms, the purchasing function has been quite specialized. In addition to protecting the cost structure of the firm, improving quality, and keeping inventory investment to a minimum, purchasing assumes a central role in managing relationships with suppliers. In turn, leading-edge organizations like Dell Computer demonstrate the critical role that purchasing and supply chain management can assume in creating profit opportunities. Rather than devoting exclusive attention to “buying for less,” leading organizations tie purchasing activities directly to corporate strategy and use a range of sophisticated e-procurement tools. Governmental units also make substantial purchases of products. Government buyers use two general purchasing strategies: the formal advertising approach for standardized products and negotiated contracts for those with unique requirements. 58 Part I The Environment of Business Marketing Institutional customers, such as health-care organizations and universities, comprise the third sector of the business market. Depending on size, the institution employs a purchasing agent and, in large institutions, a sizable purchasing department. Across business market sectors, purchasing managers are using the Internet to identify potential suppliers, conduct online reverse auctions, and communicate with suppliers. Diversity is the characteristic that typifies the institutional market. The characteristics, orientations, and purchasing processes of institutional buyers are somewhere between commercial enterprises and government buyers. Cooperative purchasing—a unique aspect of this segment—necessitates a special strategic response by potential suppliers. Many business marketers have found that a market-centered organization provides the specialization required to meet the needs of each market sector. Discussion Questions 1. A small manufacturer developed a new high-speed packaging system that could be appealing to food-processing firms like Pillsbury and General Mills. This new packaging system is far more efficient but must be priced 15 percent higher than competitors’ products. Because purchasing managers evaluate the “total cost of ownership” of major purchases, what selling points should the business marketer emphasize to demonstrate the superiority of this new product? 2. Honda of America relies on 400 suppliers in North America to provide more than 60 percent of the parts and materials for the Accord. What strategies could a business marketer follow in becoming a new supplier to Honda? What criteria would Honda consider in evaluating suppliers? 3. Describe the total-cost-of-ownership orientation that purchasing managers use and illustrate how you could apply it to your next automobile purchase decision. 4. Segmentation is a tool that marketers use to identify target markets. Increasingly, purchasing managers are using the segmentation approach to determine which suppliers are most critical to the goals of the organization. Explain. 5. Compare and contrast the two general procurement strategies employed by the federal government: (1) formal advertising and (2) negotiated contract. 6. Institutional buyers fall somewhere between commercial enterprises and government buyers in terms of their characteristics, orientation, and purchasing process. Explain. 7. Explain how the decision-making process that a university might employ in selecting a new computer would differ from that of a commercial enterprise. Who would be the key participants in the process in each setting? 8. Fearing red tape and mounds of paperwork, Tom Bronson, president of B&E Electric, has always avoided the government market. A recent discussion with a colleague, however, has rekindled Tom’s interest in Chapter 2 The Business Market: Perspectives on the Organizational Buyer 59 this sector. What steps should B&E Electric take to learn more about this market? 9. General Electric (GE) has embraced e-purchasing and has saved more than $500 million per year by conducting online reverse auctions in buying a range of goods, including office, computer, and maintenance supplies. What new challenges and opportunities does this auctioning process present for business marketers who serve GE? 10. One purchasing executive observed, “Online auctioning is an appropriate way to buy some categories of products and services but it’s entirely inappropriate for others.” Agree or disagree? Provide support for your position. Internet Exercises 1. GE Healthcare has developed an e-commerce initiative to support its marketing strategy, which targets health-care organizations on a worldwide basis. Go to http://www.gemedicalsystems.com and a. identify the products and services that the GE unit offers, and b. provide a critique of the Web site and consider the degree to which it provides access to the information that a potential buyer might want. 2. Ariba, Inc., is a leading provider of e-procurement software solutions. Go to http://www.ariba.com and a. describe the key products and services that the firm offers to its customers, and b. review a case history that describes a particular customer and how it has applied one of Ariba’s procurement solutions. CASE Sealed Air Corporation: Delivering Packaging Solutions43 Sealed Air Corporation is a global leader in providing business customers with performance solutions for food, protective, and specialty packaging. Best known for its BubbleWrap® cushioning material, the firm has pioneered a number of packaging innovations that have sustained a remarkable pattern of sales growth for more than two decades. Using a consultative selling approach, field sales and technical support specialists at Sealed Air incorporate both packaging materials and specialized equipment to provide a complete packaging solution for customers, providing superior protection against shock, abrasion, and vibration, compared with other forms of packaging. Let’s explore the packaging solution that Sealed Air developed for Davis Neon Inc., a wholesale neon sign manufacturer in Heath Springs, South Carolina. Protecting custom-made neon signs that are shipped worldwide is a challenging problem for Dave Lytle, shipping manager at Davis Neon. “We were using preformed polyethylene foam sheets, which required a lot of storage space and time to unload from the trucks,” noted Lytle. “We were keeping our eyes open for an alternative packaging method which would provide comparable protection, yet reduce costs and increase productivity.” After evaluating several alternatives, Dave Lytle chose a solution proposed by Sealed Air to package the neon signs—Instapak Continuous Foam Tubes made by Sealed Air’s SpeedyPacker Insight system. Using the SpeedyPacker equipment, now installed in the shipping area at Davis Neon, an operator can create numerous variations of foam bags at the touch of a button. For each neon sign, Davis Neon employees create a custom-made wooden crate with dimensions just large enough to house the sign. The packager then puts a layer of foam tubes, made-to-order by the Speedy Packer equipment, on the bottom of the crate to form a pad. BubbleWrap cushioning is used on the back of the sign, between rows, and on the side to provide surface protection and prevent abrasion of the sign against the crate. Another layer of foam tubes is added on top before the lid is attached to the crate. Before implementing the Sealed Air solution, packagers used preformed polyethylene foam sheets, each of which had to be cut by hand to fit the crate for the bottom pad and top layer, as well as to fit in between the letters on the neon sign. “The preformed polyethylene foam sheets took a long time to cut, were expensive, and produced significant material waste,” stated Lytle. “After working with the new packaging system, the actual savings are 62 percent in material costs. We have also seen productivity increase by 20 percent.” Employees at Davis are now able to pack more crates in less time. Discussion Questions 1. Given the significant value that Sealed Air can provide for a customer, like Davis Neon Inc., what approach should they follow in pricing a particular packaging solution for a customer? 2. Develop a list of other types of customers who face special packaging challenges and may represent promising customer prospects for Sealed Air to target. 43 Case History, “Sealed Air Sheds Light on Davis Neon’s Packaging,” accessed at www.sealedair.com on June 6, 2008. 60 PART II MANAGING RELATIONSHIPS IN BUSINESS MARKETING 61 This page intentionally left blank CHAPTER 3 Organizational Buying Behavior A wide array of forces inside and outside the organization influence the organizational buyer. Knowledge of these forces provides the marketer with a foundation for responsive business marketing strategies. After reading this chapter, you will understand: 1. the decision process organizational buyers apply as they confront differing buying situations and the resulting strategy implications for the business marketer. 2. the individual, group, organizational, and environmental variables that influence organizational buying decisions. 3. a model of organizational buying behavior that integrates these important influences. 4. how a knowledge of organizational buying characteristics enables the marketer to make more informed decisions about product design, pricing, and promotion. 63 64 Part II Managing Relationships in Business Marketing FIGURE 3.1 WANT TO WIN THE SUPPORT OF BUYING INFLUENTIALS? ENHANCE THEIR CUSTOMERS’ EXPERIENCE As a leading supplier to foreign and domestic automakers, Johnson Controls centers marketing research and R&D investments on making the automotive experience safer and more pleasurable for drivers. As a result, design engineers are eager to enhance customer value by incorporating the firm’s components in new models. To spark innovation, Johnson Controls’ R&D processes include: • Human Factor Studio, where seating, electronics, and interior components are tested based on ease of reach, usability, and function, giving special attention to ergonomic positioning. • Comfort Lab, which takes vehicle passengers on a road trip via simulator that generates the bumps, dips, and turns of an open-road drive. Here, automakers can even analyze prototype designs before production. • Wave Lab, where the acoustic and vibration properties of automotive interior components can be tested to remove, by design, sounds that cause annoyance or displeasure. The ultimate goal: providing design engineers and their customers—auto buyers—quieter and more comfortable automobile interiors. SOURCES: “JCI Labs Spark Innovation: Improving the Customer Experience through Research and Development,” accessed at http://www.johnsoncontrols.com on December 4, 2008; and “Beyond Bunsen Burners: Science Takes New Forms at Johnson Controls’ Innovative Testing Labs,” accessed at http://www.johnsoncontrols.com on December 4, 2008. Market-driven business firms continuously sense and act on trends in their markets. Consider Johnson Controls, Inc., a diverse, multi-industry company that is a leading supplier of auto interiors (including seats, electronics, headliners, and instrument panels) to manufacturers.1 The striking success of the firm rests on the close relationships that its sales reps and marketing managers have formed with design engineers and purchasing executives in the auto industry. To illustrate, some of Johnson Controls’ salespersons work on-site with design teams at Ford, GM, or Honda. To provide added value to the new-product-design process, the firm also invests annually in market research on the needs and preferences of auto buyers—the customer’s customer! (Figure 3.1) For example, based on extensive research about how families spend their time in cars, Johnson Controls developed a unique rear seat entertainment system that allows passengers to play video games, watch DVDs, or listen to CDs through wireless headphones or the vehicle’s speaker system. Moreover, to enhance the customer experience, technicians at Johnson Controls’ research lab test seating and interior components for comfort, safety, ease-of-reach, usability, and function. Using a simulator that generates the bumps, dips, and turns of an open-road drive, scientists can record the passengers’ experience and capture valuable information for developing components that improve comfort and safety as well as customer satisfaction. By staying close to the needs of auto buyers, Johnson Controls became the preferred supplier to design engineers who are continually seeking innovative ways to make auto interiors more distinctive and inviting. 1 “JCI Labs Spark Innovation,” accessed at http://www.johnsoncontrols.com on June 3, 2008. Chapter 3 FIGURE 3.2 Organizational Buying Behavior 65 MAJOR STAGES OF THE ORGANIZATIONAL BUYING PROCESS Stage Description 1. Problem Recognition Managers at P&G need new high-speed packaging equipment to support a new product launch. 2. General Description of Need Production managers work with a purchasing manager to determine the characteristics needed in the new packaging system. 3. Product Specifications An experienced production manager assists a purchasing manager in developing a detailed and precise description of the needed equipment. 4. Supplier Search After conferring with production managers, a purchasing manager identifies a set of alternative suppliers that could satisfy P&G’s requirements. 5. Acquisition and Analysis of Proposals Alternative proposals are evaluated by a purchasing manager and a number of members of the production department. 6. Supplier Selection Negotiations with the two finalists are conducted, and a supplier is chosen. 7. Selection of Order Routine A delivery date is established for the production equipment. 8. Performance Review After equipment is installed, purchasing and production managers evaluate the performance of the equipment and the service support provided by the supplier. Understanding the dynamics of organizational buying behavior is crucial for identifying profitable market segments, locating buying influences within these segments, and reaching organizational buyers efficiently and effectively with an offering that responds to their needs. Each decision the business marketer makes is based on organizational buyers’ probable response. This chapter explores the key stages of the organizational buying process and isolates the salient characteristics of different purchasing situations. Next, attention turns to the myriad forces that influence organizational buying behavior. Knowledge of how organizational buying decisions are made provides the business marketer with a solid foundation for building responsive marketing strategies. The Organizational Buying Process Organizational buying behavior is a process, not an isolated act or event. Tracing the history of a procurement decision uncovers critical decision points and evolving information requirements. In fact, organizational buying involves several stages, each of which yields a decision. Figure 3.2 lists the major stages in the organizational buying process.2 2 The discussion in this section is based on Patrick J. Robinson, Charles W. Faris, and Yoram Wind, Industrial Buying and Creative Marketing (Boston: Allyn and Bacon, 1967), pp. 12–18; see also Jeffrey E. Lewin and Naveen Donthu, “The Influence of Purchase Situations on buying Center Structure and Investment: A Select Meta-Analysis of Organizational Buying Behavior Research,” Journal of Business Research 58 (October 2005), pp. 1381–1390; and Morry Ghingold and David T. Wilson, “Buying Center Research and Business Marketing Practice: Meeting the Challenge of Dynamic Marketing,” Journal of Business & Industrial Marketing, 13 (2, 1998): pp. 96–108. 66 Part II Managing Relationships in Business Marketing The purchasing process begins when someone in the organization recognizes a problem that can be solved or an opportunity that can be captured by acquiring a specific product. Problem recognition can be triggered by internal or external forces. Internally, a firm like P&G may need new high-speed production equipment to support a new product launch. Or a purchasing manager may be unhappy with the price or service of an equipment supplier. Externally, a salesperson can precipitate the need for a product by demonstrating opportunities for improving the organization’s performance. Likewise, business marketers also use advertising to alert customers to problems and demonstrate how a particular product may solve them. During the organizational buying process, many small or incremental decisions are made that ultimately translate into the final choice of a supplier. To illustrate, a production manager might unknowingly establish specifications for a new production system that only one supplier can meet (Stages 2 and 3). This type of decision early in the buying process dramatically influences the favorable evaluation and ultimate selection of that supplier. The Search Process Once the organization has defined the product that meets its requirements, attention turns to this question: Which of the many possible suppliers are promising candidates? The organization invests more time and energy in the supplier search when the proposed product has a strong bearing on organizational performance. When the information needs of the buying organization are low, Stages 4 and 5 occur simultaneously, especially for standardized items. In this case, a purchasing manager may merely check a catalog or secure an updated price from the Internet. Stage 5 emerges as a distinct category only when the information needs of the organization are high. Here, the process of acquiring and analyzing proposals may involve purchasing managers, engineers, users, and other organizational members. Supplier Selection and Performance Review After being selected as a chosen supplier (Stage 6) and agreeing to purchasing guidelines (Stage 7), such as required quantities and expected time of delivery, a marketer faces further tests. A performance review is the final stage in the purchasing process. The performance review may lead the purchasing manager to continue, modify, or cancel the agreement. A review critical of the chosen supplier and supportive of rejected alternatives can lead members of the decision-making unit to reexamine their position. If the product fails to meet the needs of the using department, decision makers may give further consideration to vendors screened earlier in the procurement process. To keep a new customer, the marketer must ensure that the buying organization’s needs have been completely satisfied. Failure to follow through at this critical stage leaves the marketer vulnerable. The stages in this model of the procurement process may not progress sequentially and may vary with the complexity of the purchasing situation. For example, some of the stages are compressed or bypassed when organizations make routine buying decisions. However, the model provides important insights into the organizational buying process. Certain stages may be completed concurrently; the process may be discontinued by a change in the external environment or in upper-management thinking. The organizational buying process is shaped by a host of internal and external forces, such as changes in economic or competitive conditions or a basic shift in organizational priorities. Chapter 3 Organizational Buying Behavior 67 Organizations with significant experience in purchasing a particular product approach the decision quite differently from first-time buyers. Therefore, attention must center on buying situations rather than on products. Three types of buying situations have been delineated: (1) new task, (2) modified rebuy, and (3) straight rebuy.3 New Task In the new-task buying situation, organization decisions makers perceive the problem or need as totally different from previous experiences; therefore, they need a significant amount of information to explore alternative ways of solving the problem and searching for alternative suppliers. When confronting a new-task buying situation, organizational buyers operate in a stage of decision making referred to as extensive problem solving.4 The buying influentials and decision makers lack well-defined criteria for comparing alternative products and suppliers, but they also lack strong predispositions toward a particular solution. In the consumer market, this is the same type of problem solving an individual or household might follow when buying a first home. Buying-Decision Approaches5 Two distinct buying-decision approaches are used: judgmental new task and strategic new task. The greatest level of uncertainty confronts firms in judgmental new-task situations because the product may be technically complex, evaluating alternatives is difficult, and dealing with a new suppliers has unpredictable aspects. Consider purchasers of a special type of production equipment who are uncertain about the model or brand to choose, the suitable level of quality, and the appropriate price to pay. For such purchases, buying activities include a moderate amount of information search and a moderate use of formal tools in evaluating key aspects of the buying decision. Even more effort is invested in strategic new-task decisions. These purchasing decisions are of extreme importance to the firm strategically and financially. If the buyer perceives that a rapid pace of technological change surrounds the decision, search effort is increased but concentrated in a shorter time period.6 Long-range planning drives the decision process. To illustrate, a large health insurance company placed a $600,000 order for workstation furniture. The long-term effect on the work environment shaped the 6-month decision process and involved the active participation of personnel from several departments. 3 Robinson, Faris, and Wind, Industrial Buying and Creative Marketing, chap. 1; see also Erin Anderson, Wujin Chu, and Barton Weitz, “Industrial Purchasing: An Empirical Exploration of the Buyclass Framework,” Journal of Marketing 51 (July 1987): pp. 71–86; and Morry Ghingold, “Testing the ‘Buygrid’ Buying Process Model,” Journal of Purchasing and Materials Management 22 (Winter 1986): pp. 30–36. 4 The levels of decision making discussed in this section are drawn from John A. Howard and Jagdish N. Sheth, The Theory of Buyer Behavior (New York: John Wiley and Sons, 1969), chap. 2. 5 The discussion of buying decision approaches in this section is drawn from Michele D. Bunn, “Taxonomy of Buying Decision Approaches,” Journal of Marketing 57 (January 1993): pp. 38–56; see also, Michele D. Bunn, Gul T. Butaney, and Nicole P. Huffman, “An Empirical Model of Professional Buyers’ Search Effort,” Journal of Business-to-Business Marketing 8 (4, 2001): pp. 55–81. 6 Allen M. Weiss and Jan B. Heide, “The Nature of Organizational Search in High Technology Markets,” Journal of Marketing Research 30 (May 1993): pp. 230–233. See also, Christian Homburg and Sabine Kuester, “Towards an Improved Understanding of Industrial Buying Behavior: Determinants of the Number of Suppliers,” Journal of Business-to-Business Marketing 8 (2, 2001): pp. 5–29. 68 Part II Managing Relationships in Business Marketing Strategy Guidelines The business marketer confronting a new-task buying situation can gain a differential advantage by participating actively in the initial stages of the procurement process. The marketer should gather information on the problems facing the buying organization, isolate specific requirements, and offer proposals to meet the requirements. Ideas that lead to new products often originate not with the marketer but with the customer. Marketers who are presently supplying other items to the organization (“in” suppliers) have an edge over other firms: They can see problems unfolding and are familiar with the “personality” and behavior patterns of the organization. The successful business marketer carefully monitors the changing needs of organizations and is prepared to assist new-task buyers. Straight Rebuy When there is a continuing or recurring requirement, buyers have substantial experience in dealing with the need and require little or no new information. Evaluation of new alternative solutions is unnecessary and unlikely to yield appreciable improvements. Thus, a straight rebuy approach is appropriate. Routine problem solving is the decision process organizational buyers employ in the straight rebuy. Organizational buyers apply well-developed choice criteria to the purchase decision. The criteria have been refined over time as the buyers have developed predispositions toward the offerings of one or a few carefully screened suppliers. In the consumer market, this is the same type of problem solving that a shopper might use in selecting 30 items in 20 minutes during a weekly trip to the supermarket. Indeed, many organizational buying decisions made each day are routine. For example, organizations of all types are continually buying operating resources—the goods and services needed to run the business, such as computer and office supplies, maintenance and repair items, and travel services. Procter & Gamble alone spends more than $5 billion annually on operating resources.7 Buying Decision Approaches Research suggests that organizational buyers employ two buying-decision approaches: causal and routine low priority. Causal purchases involve no information search or analysis and the product or service is of minor importance. The focus is simply on transmitting the order. In contrast, routine low-priority decisions are somewhat more important to the firm and involve a moderate amount of analysis. Describing the purchase of $5,000 worth of cable to be used as component material, a buyer aptly describes this decision-process approach: On repeat buys, we may look at other sources or alternate methods of manufacturing, etc. to make sure no new technical advancements are available in the marketplace. But, generally, a repeat buy is repurchased from the supplier originally selected, especially for low dollar items. Strategy Guidelines The purchasing department handles straight rebuy situations by routinely selecting a supplier from a list of approved vendors and then placing an order. As organizations shift to e-procurement systems, purchasing managers retain control of the process for these routine purchases while allowing individual employees to directly 7 Doug Smock, “Strategic Sourcing: P&G Boosts Leverage,” Purchasing 133 (November 4, 2004): pp. 40–43. Chapter 3 Organizational Buying Behavior 69 buy online from approved suppliers.8 Employees use a simple point-and-click interface to navigate through a customized catalog detailing the offerings of approved suppliers, and then order required items. Individual employees like the self-service convenience, and purchasing managers can direct attention to more critical strategic issues. Marketing communications should be designed to reach not only purchasing managers but also individual employees who are now empowered to exercise their product preferences. The marketing task appropriate for the straight rebuy situation depends on whether the marketer is an “in” supplier (on the list) or an “out” supplier (not among the chosen few). An “in” supplier must reinforce the buyer-seller relationship, meet the buying organization’s expectations, and be alert and responsive to the changing needs of the organization. The “out” supplier faces a number of obstacles and must convince the organization that it can derive significant benefits from breaking the routine. This can be difficult because organizational buyers perceive risk in shifting from the known to the unknown. The organizational spotlight shines directly on them if an untested supplier falters. Buyers may view testing, evaluations, and approvals as costly, time-consuming, and unnecessary. The marketing effort of the “out” supplier rests on an understanding of the basic buying needs of the organization: Information gathering is essential. The marketer must convince organizational buyers that their purchasing requirements have changed or that the requirements should be interpreted differently. The objective is to persuade decision makers to reexamine alternative solutions and revise the preferred list to include the new supplier. Modified Rebuy In the modified rebuy situation, organizational decision makers feel they can derive significant benefits by reevaluating alternatives. The buyers have experience in satisfying the continuing or recurring requirement, but they believe it worthwhile to seek additional information and perhaps to consider alternative solutions. Several factors may trigger such a reassessment. Internal forces include the search for quality improvements or cost reductions. A marketer offering cost, quality, or service improvements can be an external precipitating force. The modified rebuy situation is most likely to occur when the firm is displeased with the performance of present suppliers (for example, poor delivery service). Limited problem solving best describes the decision-making process for the modified rebuy. Decision makers have well-defined criteria but are uncertain about which suppliers can best fit their needs. In the consumer market, college students buying their second computer might follow a limited problem-solving approach. Buying-Decision Approaches Two buying-decision approaches typify this buying-class category. Both strongly emphasize the firm’s strategic objectives and long-term needs. The simple modified rebuy involves a narrow set of choice alternatives and a moderate amount of both information search and analysis. Buyers concentrate on the long-term-relationship potential of suppliers. 8 Talai Osmonbekov, Daniel C. Bello, and David I Gillilard, “Adoption of Electronic Commerce Tools in Business Procurement: Enhanced Buying Center Structure and Processes,” Journal of Business & Industrial Marketing 17 (2/3, 2002): pp. 151–166. 70 Part II Managing Relationships in Business Marketing The complex modified rebuy involves a large set of choice alternatives and poses little uncertainty. The range of choice enhances the buyer’s negotiating strength. The importance of the decision motivates buyers to actively search for information, apply sophisticated analysis techniques, and carefully consider long-term needs. This decision situation is particularly well suited to a competitive bidding process. For example, some firms are turning to online reverse auctions (one buyer, many sellers), where the buying organization allows multiple suppliers to bid on a contract, exerting downward price pressure throughout the process. To participate, suppliers must be prepared to meet defined product characteristics, as well as quality and service standards. “And while price will always be an issue, more buyers today use reverse auctions to determine the best value.”9 Rather than being used for specialized products or services where a close working relationship with the supplier is needed, auctions tend to be used for commodities and standardized parts. Strategy Guidelines In a modified rebuy, the direction of the marketing effort depends on whether the marketer is an “in” or an “out” supplier. An “in” supplier should make every effort to understand and satisfy the procurement need and to move decision makers into a straight rebuy. The buying organization perceives potential payoffs by reexamining alternatives. The “in” supplier should ask why and act immediately to remedy any customer problems. The marketer may be out of touch with the buying organization’s requirements. The goal of the “out” supplier should be to hold the organization in modified rebuy status long enough for the buyer to evaluate an alternative offering. Knowing the factors that led decision makers to reexamine alternatives could be pivotal. A particularly effective strategy for an “out” supplier is to offer performance guarantees as part of the proposal.10 To illustrate, the following guarantee prompted International Circuit Technology, a manufacturer of printed circuit boards, to change to a new supplier for plating chemicals: “Your plating costs will be no more than x cents per square foot or we will make up the difference.”11 Given the nature of the production process, plating costs can be easily monitored by comparing the square footage of circuit boards moving down the plating line with the cost of plating chemicals for the period. Pleased with the performance, International Circuit Technology now routinely reorders from this new supplier. Strategy Implications Although past research provides some useful guidelines, marketers must exercise great care in forecasting the likely composition of the buying center for a particular purchasing situation.12 The business marketer should attempt to identify purchasing patterns that apply to the firm. For example, the classes of industrial goods introduced in Chapter 1 (such as foundation goods versus facilitating goods) involve varying degrees of technical complexity and financial risk for the buying organization. 9 James Carbone, “Not Just a Cost Reduction Tool,” Purchasing 134 (February 17, 2005): p. 43. 10 Mary Siegfried Dozbaba, “Critical Supplier Relationships: Converting Higher Performance,” Purchasing Today (February 1999): pp. 22–29. 11 Somerby Dowst, “CEO Report: Wanted: Suppliers Adept at Turning Corners,” Purchasing 101 (January 29, 1987): pp. 71–72. 12 Donald W. Jackson Jr., Janet E. Keith, and Richard K. Burdick, “Purchasing Agents’ Perceptions of Industrial Buying Center Influence,” Journal of Marketing 48 (fall 1984): pp. 75–83. Chapter 3 FIGURE 3.3 Organizational Buying Behavior 71 FORCES INFLUENCING ORGANIZATIONAL BUYING BEHAVIOR Illustrative Dimensions Environmental Forces • Economic Outlook: Domestic & Global • Pace of Technological Change • Global Trade Relations Organizational Forces • Goals, Objectives, and Strategies • Organizational Position of Purchasing Group Forces • Roles, relative influence, and patterns of interaction of buying decision participants Individual Forces • Job function, past experience, and buying motives of individual decision partcipants Organizational Buying Behavior The business marketer must therefore view the procurement problem or need from the buying organization’s perspective. How far has the organization progressed with the specific purchasing problem? How does the organization define the task at hand? How important is the purchase? The answers direct and form the business marketer’s response and also provide insight into the composition of the decision-making unit. Forces Shaping Organizational Buying Behavior The eight-stage model of the organizational buying process provides the foundation for exploring the myriad forces that influence a buying decision by an organization. Observe in Figure 3.3 how organizational buying behavior is influenced by environmental forces (for example, the growth rate of the economy); organizational forces (for example, the size of the buying organization); group forces (for example, patterns of influence in buying decisions); and individual forces (for example, personal preferences). Environmental Forces A projected change in business conditions, a technological development, or a new piece of legislation can drastically alter organizational buying plans. Among the environmental forces that shape organizational buying behavior are economic, political, 72 Part II Managing Relationships in Business Marketing legal, and technological influences. Collectively, such environmental influences define the boundaries within which buyer-seller relationships develop. Particular attention is given to selected economic and technological forces that influence buying decisions. Economic Influences Because of the derived nature of industrial demand, the marketer must be sensitive to the strength of demand in the ultimate consumer market. The demand for many industrial products fluctuates more widely than the general economy. Firms that operate on a global scale must be sensitive to the economic conditions that prevail across regions. For example, while the United States, western Europe, and Japan may experience modest increases (for example, 2 or 3 percent) in gross domestic product (GDP) in the years ahead, rapidly developing economies (RDEs) are projected to grow three or four times as fast. In addition to China and India, key RDEs include Mexico, Brazil, central and eastern Europe, and southeast Asia.13 A wealth of political and economic forces dictate the vitality and growth of an economy. A recent study found that the number of North American companies purchasing goods and services from China, eastern Europe, and India has increased sharply in recent years and will continue to rise.14 Best-in-class procurement organizations are twice as likely as their competitors to emphasize low-cost-country sourcing strategies.15 Demonstrating this trend, IBM recently moved its procurement headquarters to Shenzhen, China! The economic environment influences an organization’s ability and, to a degree, its willingness to buy. However, shifts in general economic conditions do not affect all sectors of the market evenly. For example, a rise in interest rates may damage the housing industry (including lumber, cement, and insulation) but may have minimal effects on industries such as paper, hospital supplies, office products, and soft drinks. Marketers that serve broad sectors of the organizational market must be particularly sensitive to the differential effect of selective economic shifts on buying behavior. Technological Influences Rapidly changing technology can restructure an industry and dramatically alter organizational buying plans. Notably, the World Wide Web “has forever changed the way companies and customers (whether they be consumers or other businesses) buy and sell to each other, learn about each other, and communicate.”16 The rate of technological change in an industry influences the composition of the decision-making unit in the buying organization. As the pace of technological change increases, the importance of the purchasing manager in the buying process declines. Technical and engineering personnel tend to be more important when the rate of technological change is great. Recent research also suggests that buyers who perceive the pace of technological change to be more rapid (1) conduct more intense search efforts and (2) spend less time on their overall search processes.17 Allen Weiss and 13 Satish Shankar, Charles Ormiston, Nicholas Bloch, Robert Schaus, and Vijay Vishwanath, “How to Win in Emerging Markets,” MIT Sloan Management Review 49 (Spring 2008): pp. 19–23. 14 “Global Procurement Study Finds Companies Unprepared to Manage Increased Sourcing from China and India Effectively,” accessed at http://www.atkearney.com on May 18, 2005. 15 Andrew Bartolini, “CPO Rising: The CPO’s Agenda for 2008,” February 2008, research report by the Aberdeen Group, accessed at http://www.aberdeen.com on May 25, 2008. 16 Stewart Alsop, “e or Be Eaten,” Fortune, November 8, 1999, p. 87. 17 Weiss and Heide, “The Nature of Organizational Search,” pp. 220–233; see also Jan B. Heide and Allen M. Weiss, “Vendor Consideration and Switching Behavior for Buyers in High-Technology Markets,” Journal of Marketing 59 (July 1995): pp. 30–43. Chapter 3 Organizational Buying Behavior 73 Jan Heide suggest that “in cost-benefit terms, a fast pace of change implies that distinct benefits are associated with search effort, yet costs are associated with prolonging the process” because the acquired information is “time sensitive.”18 The marketer must also actively monitor signs of technological change and be prepared to adapt marketing strategy to deal with new technological environments. For example, Hewlett-Packard has embraced the Internet in its products, services, practices, and marketing. With search engines, spam filters, iPods, and other technologies, customers now have more control of the information they receive than ever before, notes Scott Anderson, director of enterprise brand communication at HewlettPackard. In this dynamic environment, “our strategy is to engage our customers with online interactions and content,” he says, pointing to the Web, e-mail, broadband, and blogs as just some of the many electronic tools H-P uses.19 Similarly, Dell, Inc., now has an entire team dedicated to finding and responding to comments about Dell on the Internet and to creating buzz among bloggers concerning forthcoming product releases.20 Because the most recent wave of technological change is as dramatic as any in history, the implications for marketing strategists are profound. They involve changing definitions of industries, new sources of competition, changing product life cycles, and the increased globalization of markets.21 Organizational Forces An understanding of the buying organization is based on its strategic priorities, the role of purchasing in the executive hierarchy, and the firm’s competitive challenges. Growing Influence of Purchasing As a rule, the influence of the procurement function is growing. Why? Globalization is upsetting traditional patterns of competition, and companies are feeling the squeeze from rising material costs and stiff customer resistance to price increases. Meanwhile, to enhance efficiency and effectiveness, many firms are outsourcing some functions that were traditionally performed within the organization. As a result, at companies around the world, CEOs are counting on the procurement function to keep their businesses strongly positioned in today’s intensively competitive marketplace.22 Strategic Priorities in Purchasing As the influence of purchasing grows, chief procurement officers feel the heat of the spotlight, so they are pursuing an ambitious set of strategic priorities (Table 3.1). They seek cost savings but realize that such savings are only part of what procurement can contribute to the bottom line. More importantly, however, procurement executives are turning to a more strategic question: How can procurement become a stronger competitive weapon? Here attention centers on corporate goals and how procurement can 18 Weiss and Heide, “The Nature of Organizational Search,” p. 221. 19 Kate Maddox, Sean Callahan, and Carol Krol, “Top Trends: B-to-B Marketers Have Proven Remarkably Adaptable in the Last Five Years,” B to B, June 13, 2005, p. 3, accessed at http://www.BtoBonline.com on July 7, 2005. 20 Ken Worthen, “Dell, by Going Click for Click with Web Posters, Ensured Bloggers Saw Its New Red Mini Laptop,” Wall Street Journal, June 3, 2008, p. B6. 21 Rashi Glazer, “Winning in Smart Markets,” Sloan Management Review 40 (Summer 1999): pp. 56–69. 22 Marc Bourde, Charlie Hawker, and Theo Theocharides, “Taking Center Stage: The 2005 Chief Procurement Officer Survey” (Somers, NY: IBM Global Services, May 2005), pp. 1–14, accessed at http://www.ibm.com/bcs on July 1, 2005. 74 Part II Managing Relationships in Business Marketing TABLE 3.1 STRATEGIC PRIORITIES IN PURCHASING Aligning Purchasing with Strategy: Not Just Buyers Exploring New Value Frontiers: It’s Not Just about Price Putting Suppliers Inside: The Best Value Chain Wins Pursuing Low-Cost Sources: A World Worth Exploring Shift from an administrative role to a value-creating function that serves internal stakeholders and provides a competitive edge in the market. Focus on the capabilities of suppliers emphasizing business outcomes, total cost of ownership, and the potential for long-term value creation. Develop fewer and deeper relationships with strategic suppliers and involve them in decision-making processes, ranging from new product development to cost-reduction initiatives. Overcome hurdles imposed by geographical differences and seek out cost-effective suppliers around the globe. SOURCE: Adapted from Marc Bourde, Charlie Hawker, and Theo Theocharides, “Taking Center Stage: The 2005 Chief Procurement Officer Survey,” (Somers, N.Y.: IBM Global Services, May 2005), pp. 1–14. Accessed at http://www.ibm.com/ bcs on July 1, 2005; and Chip W. Hardt, Nicholas Reinecke, and Peter Spiller, “Inventing the 21st-Century Purchasing Organization,” The McKinsey Quarterly 2007, No. 4, pp. 115–124. help their internal customers (that is, other business functions) achieve these goals. As a direct participant in the strategy process, procurement managers are giving increased emphasis to suppliers’ capabilities, exploring new areas where a strategic supplier can add value to the firm’s product or service offerings. Robert K. Harlan, director of e-procurement at Motorola, captures the idea: For new product development, “we bring many suppliers in early to design, simplify, and implement new technologies.”23 Leading-edge purchasing organizations have also learned that the “best value chain wins,” so they are building closer relationships with a carefully chosen set of strategic suppliers and aligning the activities of the supply chain with customers’ needs.24 For example, Honda of America reduced the cost of the Accord’s purchased content by setting cost targets for each component—engine, chassis, and so on.25 Then, purchasing managers worked with global suppliers to understand the cost structure of each component, observe how it is manufactured, and identify ways to reduce costs, add value, or do both. Offer Strategic Solutions As purchasing assumes a more strategic role, the business marketer must understand the competitive realities of the customer’s business and develop a value proposition—products, services, ideas—that advance its performance goals. For example, IBM centers attention on customer solutions—how its information technology and assorted services can improve the efficiency of a retailer’s operations or advance the customer service levels of a hotel chain. Alternatively, a supplier to Hewlett-Packard will strike a responsive chord with executives by offering a new component that will increase the performance or lower the cost of its inkjet printers. To provide such customer solutions, the business marketer needs an intimate understanding of the opportunities and threats that the customer confronts. 23 Jason Seigel, “Professional Profile: Robert K. Harlan,” Purchasing 13 (October 7, 2004): p. 32. 24 Mark Gottfredson, Rudy Puryear, and Stephen Phillips, “Strategic Sourcing: From Periphery to the Core,” Harvard Business Review 83 (February 2005): pp. 132–139. 25 Timothy M. Laseter, Balanced Sourcing: Cooperation and Competition in Supplier Relationships (San Francisco: Jossey-Bass, 1998), pp. 5–18. Chapter 3 Organizational Buying Behavior 75 Organizational Positioning of Purchasing As purchasing moves from a transaction-based support role and assumes a more prominent strategic spot at the executive level, many leading firms are centralizing the procurement function. An organization that centralizes procurement decisions approaches purchasing differently than a company in which purchasing decisions are made at individual user locations. When purchasing is centralized, a separate organizational unit has authority for purchases at a regional, divisional, or headquarters level. For example, by centralizing procurement, American Express realized nearly $600 million in purchasing savings in the first three years.26 IBM, Sara Lee, 3M, Hewlett-Packard, Wendy’s International, and Citicorp are among other corporations that emphasize centralized procurement. A marketer who is sensitive to organizational influences can more accurately map the decision-making process, isolate buying influentials, identify salient buying criteria, and target marketing strategy for both centralized, as well as decentralized, organizations.27 Centralization of Procurement: Contributing Factors Several factors contribute to the trend toward centralizing purchasing. First, centralization can better integrate purchasing strategy with corporate strategy, and e-procurement software tools now enable managers to monitor and analyze corporate spending data in minute detail.28 Importantly, e-procurement software from firms such as Ariba, Inc. (http:// www.ariba.com) now provides buyers with a rich set of new tools to track and manage spending across the entire enterprise. For example, the corporate procurement group at Walt Disney Company manages spending on all items common to the entertainment firm’s four business units: media networks, parks and resorts, studio entertainment, and consumer products. These items include such categories as information technology, telecommunications, construction services, and insurance.29 Second, an organization with multiple plant or office locations can often cut costs by pooling common requirements. Before Motorola centralized its procurement function, it had 65 different software agreements globally with one supplier for the same software license.30 By negotiating a global agreement that covers all Motorola operations around the world, the centralized procurement staff saved more than $40 million, or about 50 percent of what the firm had been paying for the 65 different agreements. Third, the nature of the supply environment also can determine whether purchasing is centralized. If a few large sellers dominate the supply environment, centralized buying may be particularly useful in securing favorable terms and proper service. If the supply industry consists of many small firms, each covering limited geographical areas, decentralized purchasing may achieve better support. Finally, the location of purchasing in the organization often hinges on the location of key buying influences. If engineering plays an active role in the process, the purchasing function must be in close organizational and physical proximity. 26 Susan Avery, “American Express Changes Ahead,” Purchasing 133 (November 4, 2004): pp. 34–38. 27 E. Raymond Corey, The Organizational Context of Industrial Buyer Behavior (Cambridge, MA: Marketing Science Institute, 1978), pp. 99–112. 28 Tim A. Minahan, “Best Practices in E-Sourcing: Optimizing and Sustaining Supply Savings,” September 2004, research report by Aberdeen Group, Inc., Boston, Massachusetts; accessed at http://www.ariba.com on June 15, 2005. 29 Anne Millen Porter, “Spend a Little, Save a Lot,” Purchasing 130 (April 4, 2002): pp. 23–34. 30 James Carbone, “Motorola Leverages Its Way to Lower Cost,” Purchasing 133 (September 16, 2004): p. 32. 76 Part II Managing Relationships in Business Marketing Centralization versus Decentralization Centralized and decentralized procurement differ substantially.31 Centralization leads to specialization. Purchasing specialists for selected items develop comprehensive knowledge of supply and demand conditions, vendor options, supplier cost factors, and other relevant information. This knowledge, and the significant volume of business that specialists control, enhances their buying strength and supplier options. The priority given to selected buying criteria is also influenced by centralization or decentralization. By identifying the buyer’s organizational domain, the marketer can generally identify the purchasing manager’s objectives. Centralized purchasing units place more weight on strategic considerations such as long-term supply availability and the development of a healthy supplier complex. Decentralized buyers may emphasize more tactical concerns such as short-term cost efficiency and profit considerations. Organizational buying behavior is greatly influenced by the monitoring system that measures the performance of the unit. Personal selling skills and the brand preferences of users influence purchasing decisions more at user locations than at centralized buying locations. At user locations, E. Raymond Corey points out that “engineers and other technical personnel, in particular, are prone to be specific in their preferences, while nonspecialized, nontechnical buyers have neither the technical expertise nor the status to challenge them,”32 as can purchasing specialists at central locations. Differing priorities between central buyers and local users often lead to conflict. In stimulating demand at the user level, the marketer should assess the potential for conflict and attempt to develop a strategy to resolve any differences between the two organizational units. Strategy Response The organization of the marketer’s selling strategy should parallel the organization of the purchasing function of key accounts. To avoid disjointed selling activities and internal conflict in the sales organization, and to serve the special needs of important customers, many business marketers have developed key account management programs to establish a close working relationship that, according to Benson Shapiro and Rowland Moriarty, “cuts across multiple levels, functions, and operating units in both the buying and selling organizations.”33 For example, IBM assigns a dedicated account executive to work with large customers, like Boeing or State Farm Insurance. Thus, the trend toward the centralization of procurement by buyers has been matched by the development of key account management programs by sellers. For large, multinational organizations that have the structure, processes, and information systems to centrally coordinate purchases on a global scale, the customer might be considered for global account management status. A global account management program treats a customer’s worldwide operations as one integrated account, with coherent terms for pricing, service, and product specifications.34 31 Joseph A. Bellizzi and Joseph J. Belonax, “Centralized and Decentralized Buying Influences,” Industrial Marketing Management 11 (April 1982): pp. 111–115; Arch G. Woodside and David M. Samuel, “Observation of Centralized Corporate Procurement,” Industrial Marketing Management 10 (July 1981): pp. 191–205; and Corey, The Organizational Context, pp. 6–12. 32 Corey, The Organizational Context, p. 13. 33 Benson P. Shapiro and Rowland T. Moriarty, National Account Management: Emerging Insights (Cambridge, MA: Marketing Science Institute, 1982), p. 8; see also James Boles, Wesley Johnston, and Alston Gardner, “The Selection and Organization of National Accounts: A North American Perspective,” Journal of Business & Industrial Marketing 14 (4, 1999): pp. 264–275. 34 George S. Yip and Audrey J. M. Bink, “Managing Global Accounts,” Harvard Business Review 85 (September 2007): pp. 103–111. Chapter 3 Organizational Buying Behavior 77 INSIDE BUSINESS MARKETING Go Digital to Target Buying Influentials Which firms are gaining an advantage in the customer-empowered, competitive markets that are being reshaped by the Internet? Those who already excel at managing customer relationships are best equipped to capitalize on the opportunities of the Internet. Those relationship leaders are able to anticipate earlier how to use the Internet to connect with their customers, exploit it faster, and implement strategy initiatives better. Best-ofbreed relationship builders, like Dell, FedEx, GE Medical, and Singapore Airlines, relish the new possibilities the Internet presents. Consider the effective and low-cost strategy that GE Medical uses in selling expensive, mission-critical software through the digital channel. Radiologists using GE’s diagnostic imaging machines can go to the Internet and try out new GE software that increases the efficiency of spinal examinations. If they like what they see, they can order the $65,000 software. About 65 percent of the time, radiologists elect to make the purchase, without ever talking to a salesperson. SOURCE: George S. Day and Katrina J. Hubbard, “Customer Relationships Go Digital,” Business Strategy Review 14 (1, 2003): pp. 17–26. For example, Xerox and Hewlett-Packard each have over 100 corporate clients who are given global account status. Group Forces Multiple buying influences and group forces are critical in organizational buying decisions. The organizational buying process typically involves a complex set of smaller decisions made or influenced by several individuals. The degree of involvement of group members varies from routine rebuys, in which the purchasing agent simply takes into account the preferences of others, to complex new-task buying situations, in which a group plays an active role. The industrial salesperson must address three questions. • Which organizational members take part in the buying process? • What is each member’s relative influence in the decision? • What criteria are important to each member in evaluating prospective suppliers? The salesperson who can correctly answer these questions is ideally prepared to meet the needs of a buying organization and has a high probability of becoming the chosen supplier. The Buying Center The concept of the buying center provides rich insights into the role of group forces in organizational buying behavior.35 The buying center 35 For a comprehensive review of buying center research, see Wesley J. Johnston and Jeffrey E. Lewin, “Organizational Buying Behavior: Toward an Integrative Framework,” Journal of Business Research 35 (January 1996): pp. 1–15; and J. David Lichtenthal, “Group Decision Making in Organizational Buying: A Role Structure Approach,” in Advances in Business Marketing, vol. 3, ed. Arch G. Woodside (Greenwich, CT: JAI Press, 1988), pp. 119–157. 78 Part II Managing Relationships in Business Marketing consists of individuals who participate in the purchasing decision and share the goals and risks arising from the decision. The size of the buying center varies, but an average buying center includes more than 4 persons per purchase; the number of people involved in all stages of one purchase may be as many as 20.36 The composition of the buying center may change from one purchasing situation to another and is not prescribed by the organizational chart. A buying group evolves during the purchasing process in response to the information requirements of the specific situation. Because organizational buying is a process rather than an isolated act, different individuals are important to the process at different times.37 A design engineer may exert significant influence early in the process when product specifications are being established; others may assume a more dominant role in later phases. A salesperson must define the buying situation and the information requirements from the organization’s perspective in order to anticipate the size and composition of the buying center. Again, the composition of the buying center evolves during the purchasing process, varies from firm to firm, and varies from one purchasing situation to another. Isolating the Buying Situation Defining the buying situation and determining whether the firm is in the early or later stages of the procurement decision-making process are important first steps in defining the buying center. The buying center for a new-task buying situation in the not-for-profit market is presented in Table 3.2. The product, intensive-care monitoring systems, is complex and costly. Buying center members are drawn from five functional areas, each participating to varying degrees in the process. A marketer who concentrated exclusively on the purchasing function would be overlooking key buying influentials. Erin Anderson and her colleagues queried a large sample of sales managers about the patterns of organizational buying behavior their salespeople confront daily. Sales forces that frequently encounter new-task buying situations generally observe that: The buying center is large, slow to decide, uncertain about its needs and the appropriateness of the possible solutions, more concerned about finding a good solution than getting a low price or assured supply, more willing to entertain proposals from “out” suppliers and less willing to favor “in” suppliers, more influenced by technical personnel, [and] less influenced by purchasing agents.38 By contrast, Anderson and her colleagues found that sales forces facing more routine purchase situations (that is, straight and modified rebuys) frequently observe buying centers that are “small, quick to decide, confident in their appraisals of the problem and possible solutions, concerned about price and supply, satisfied with ‘in’ suppliers, and more influenced by purchasing agents.”39 36 For example, see Robert D. McWilliams, Earl Naumann, and Stan Scott, “Determining Buying Center Size,” Industrial Marketing Management 21 (February 1992): pp. 43–49. 37 Ghingold and Wilson, “Buying Center Research and Business Marketing Practice,” pp. 96–108; see also Gary L. Lilien and M. Anthony Wong, “Exploratory Investigation of the Structure of the Buying Center in the Metalworking Industry,” Journal of Marketing Research 21 (February 1984): pp. 1–11. 38 Anderson, Chu, and Weitz, “Industrial Purchasing,” p. 82. 39 Ibid. Chapter 3 TABLE 3.2 Organizational Buying Behavior 79 THE INVOLVEMENT OF BUYING CENTER PARTICIPANTS AT DIFFERENT STAGES OF THE PROCUREMENT PROCESS Stages of Procurement Process for a Medical Supplier Identification and Buying Center Identification Establishment Evaluation of Participants of Need of Objectives Buying Alternatives Selection of Suppliers Physicians Nursing Administration Engineering Purchasing High Low High Low Moderate High Low Moderate Low Low High High Moderate Moderate Low High High Moderate Moderate Low SOURCE: Adapted by permission of the publisher from Gene R. Laczniak, “An Empirical Study of Hospital Buying,” Industrial Marketing Management 8 ( January 1979): p. 61. Copyright © 1979 by Elsevier Science. Predicting Composition A marketer can also predict the composition of the buying center by projecting the effect of the industrial product on various functional areas in the organization. If the procurement decision will affect the marketability of a firm’s product (for example, product design, price), the marketing department will be active in the process. Engineering will be influential in decisions about new capital equipment, materials, and components; setting specifications; defining product performance requirements; and qualifying potential vendors. Manufacturing executives will be included for procurement decisions that affect the production mechanism (for example, materials or parts used in production). When procurement decisions involve a substantial economic commitment or impinge on strategic or policy matters, top management will have considerable influence. Buying Center Influence Members of the buying center assume different roles throughout the procurement process. Frederick Webster Jr. and Yoram Wind have given the following labels to each of these roles: users, influencers, buyers, deciders, and gatekeepers.40 As the role name implies, users are the personnel who use the product in question. Users may have anywhere from inconsequential to extremely important influence on the purchase decision. In some cases, the users initiate the purchase action by requesting the product. They may even develop the product specifications. Gatekeepers control information to be reviewed by other members of the buying center. They may do so by disseminating printed information, such as advertisements, or by controlling which salesperson speaks to which individuals in the buying center. To illustrate, the purchasing agent might perform this screening role by opening the gate to the buying center for some sales personnel and closing it to others. Influencers affect the purchasing decision by supplying information for the evaluation of alternatives or by setting buying specifications. Typically, those in technical departments, such as engineering, quality control, and R&D, have significant influence on the purchase decision. Sometimes, outside individuals can assume this role. 40 Frederick E. Webster Jr. and Yoram Wind, Organizational Buying Behavior (Englewood Cliffs, NJ: Prentice-Hall, 1972), p. 77. For a review of buying role research, see Lichtenthal, “Group Decision Making in Organizational Buying,” pp. 119–157. 80 Part II Managing Relationships in Business Marketing INSIDE BUSINESS MARKETING Innovate and Win with BMW Leading procurement organizations expect their suppliers to innovate, and they reward them when they do. At firms such as P&G, Coca-Cola, and BMW, purchasing executives use “potential to innovate” as a key criterion for selecting suppliers and evaluate contributions to innovation as part of the supplier development process. Business marketers who contribute innovative ideas to the new-product-development process at such firms win the support of purchasing managers, marketing executives, design engineers, and other members of the buying center. For example, a salesperson for a top supplier to BMW proposed adding optic-fiber-enabled light rings to headlights to add a distinguishing feature to the brand. “Drivers on the German autobahn or elsewhere would see the distinctive lights of a high-performance BMW approaching from behind and know to move aside and let it pass. BMW and the supplier jointly developed the idea—and the contract ensures exclusive rights for the automaker.” As a result of this collaboration, BMW gained access to new technology that adds value to its brand and the supplier won a lucrative, long-term contract. SOURCE: A. T. Kearney, “Creating Value through Strategic Supply Management: 2004 Assessment of Excellence in Procurement,” (February 2005). Accessed at http://www .atkearney.com on June 25, 2005. For high-tech purchases, technical consultants often assume an influential role in the decision process and broaden the set of alternatives being considered.41 Deciders actually make the buying decision, whether or not they have the formal authority to do so. The identity of the decider is the most difficult role to determine: Buyers may have formal authority to buy, but the president of the firm may actually make the decision. A decider could be a design engineer who develops a set of specifications that only one vendor can meet. The buyer has formal authority to select a supplier and implement all procedures connected with securing the product. More powerful members of the organization often usurp the power of the buyer. The buyer’s role is often assumed by the purchasing agent, who executes the administrative functions associated with a purchase order. One person could assume all roles, or separate individuals could assume different buying roles. To illustrate, as users, personnel from marketing, accounting, purchasing, and production may all have a stake in which information technology system is selected. Thus, the buying center can be a very complex organizational phenomenon. Identifying Patterns of Influence Key influencers are frequently located outside the purchasing department. To illustrate, the typical capital equipment purchase involves an average of four departments, three levels of the management hierarchy (for example, manager, regional manager, vice president), and seven different individuals.42 41 Paul G. Patterson and Phillip L. Dawes, “The Determinants of Choice Set Structure in High-Technology Markets,” Industrial Marketing Management 28 (July 1999): pp. 395–411; and Philip L. Dawes, Don Y. Lee, and David Midgley, “Organizational Learning in High-Technology Purchase Situations: The Antecedents and Consequences of the Participation of External IT Consultants,” Industrial Marketing Management 36 (April 2007): pp. 285–299. 42 Wesley J. Johnston and Thomas V. Bonoma, “The Buying Center: Structure and Interaction Patterns,” Journal of Marketing 45 (Summer 1981): pp. 143–156; see also Gary L. Lilien and M. Anthony Wong, “An Exploratory Investigation of the Structure of the Buying Center in the Metalworking Industry,” Journal of Marketing Research 21 (February 1984): pp. 1–11; and Arch G. Woodside, Timo Liakko, and Risto Vuori, “Organizational Buying of Capital Equipment Involving Persons across Several Authority Levels,” Journal of Business & Industrial Marketing 14 (1, 1999): pp. 30–48. Chapter 3 TABLE 3.3 Organizational Buying Behavior 81 CLUES FOR IDENTIFYING POWERFUL BUYING CENTER MEMBERS • Isolate the personal stakeholders. Those individuals who have an important personal stake in the decision will exert more influence than other members of the buying center. For example, the selection of production equipment for a new plant will spawn the active involvement of manufacturing executives. • Follow the information flow. Influential members of the buying center are central to the information flow that surrounds the buying decision. Other organizational members will direct information to them. • Identify the experts. Expert power is an important determinant of influence in the buying center. Those buying center members who possess the most knowledge—and ask the most probing questions of the salesperson—are often influential. • Trace the connections to the top. Powerful buying center members often have direct access to the top-management team. This direct link to valuable information and resources enhances the status and influence of the buying center members. • Understand purchasing’s role. Purchasing is dominant in repetitive buying situations by virtue of technical expertise, knowledge of the dynamics of the supplying industry, and close working relationships with individual suppliers. SOURCE: Adapted from John R. Ronchetto, Michael D. Hutt, and Peter H. Reingen, “Embedded Influence Patterns in Organizational Buying Systems,” Journal of Marketing 53 (October 1989): pp. 51–62. In purchasing component parts, personnel from production and engineering are often most influential in the decision. It is interesting to note that a comparative study of organizational buying behavior found striking similarities across four countries (the United States, the United Kingdom, Australia, and Canada) in the involvement of various departments in the procurement process.43 Past research provides some valuable clues for identifying powerful buying center members (Table 3.3).44 To illustrate, individuals who have an important personal stake in the decision possess, expert knowledge concerning the choice, and/or are central to the flow of decision-related information tend to assume an active and influential role in the buying center. Purchasing managers assume a dominant role in repetitive buying situations. Based on their buying center research, Donald W. Jackson Jr. and his colleagues provide these strategy recommendations: Marketing efforts will depend upon which individuals of the buying center are more influential for a given decision. Because engineering and manufacturing are more influential in product selection decisions, they may have to be sold on product characteristics. On the other hand, because purchasing is most influential in supplier selection decisions, they may have to be sold on company characteristics.45 43 Peter Banting, David Ford, Andrew Gross, and George Holmes, “Similarities in Industrial Procurement across Four Countries,” Industrial Marketing Management 14 (May 1985): pp. 133–144. 44 John R. Ronchetto, Michael D. Hutt, and Peter H. Reingen, “Embedded Influence Patterns in Organizational Buying Systems,” Journal of Marketing 53 (October 1989): pp. 51–62; see also Ajay Kohli, “Determinants of Influence in Organizational Buying: A Contingency Approach,” Journal of Marketing 53 (July 1989): pp. 50–65; Daniel H. McQuiston and Peter R. Dickson, “The Effect of Perceived Personal Consequences on Participation and Influence in Organizational Buying,” Journal of Business Research 23 (September 1991): pp. 159–177; and Jerome M. Katrichis, “Exploring Departmental Level Interaction Patterns in Organizational Purchasing Decisions,” Industrial Marketing Management 27 (March 1998): pp. 135–146. 45 Jackson, Keith, and Burdick, “Purchasing Agents’ Perceptions of Industrial Buying Center Influence,” pp. 75–83. 82 Part II Managing Relationships in Business Marketing Individual Forces Individuals, not organizations, make buying decisions. Each member of the buying center has a unique personality, a particular set of learned experiences, a specified organizational function, and a perception of how best to achieve both personal and organizational goals. Importantly, research confirms that organizational members who perceive that they have an important personal stake in the buying decision participate more forcefully in the decision process than their colleagues.46 To understand the organizational buyer, the marketer should be aware of individual perceptions of the buying situation. Differing Evaluative Criteria Evaluative criteria are specifications that organizational buyers use to compare alternative industrial products and services; however, these may conflict. Industrial product users generally value prompt delivery and efficient servicing; engineering values product quality, standardization, and testing; and purchasing assigns the most importance to maximum price advantage and economy in shipping and forwarding.47 Product perceptions and evaluative criteria differ among organizational decision makers as a result of differences in their educational backgrounds, their exposure to different types of information from different sources, the way they interpret and retain relevant information (perceptual distortion), and their level of satisfaction with past purchases.48 Engineers have an educational background different from that of plant managers or purchasing agents: They are exposed to different journals, attend different conferences, and possess different professional goals and values. A sales presentation that is effective with purchasing may be entirely off the mark with engineering. Responsive Marketing Strategy A marketer who is sensitive to differences in the product perceptions and evaluative criteria of individual buying center members is well equipped to prepare a responsive marketing strategy. To illustrate, a research study examined the industrial adoption of solar air-conditioning systems and identified the criteria important to key decision makers.49 Buying center participants for this purchase typically include production engineers, heating and air-conditioning (HVAC) consultants, and top managers. The study revealed that marketing communications directed at production engineers should center on operating costs and energy savings; HVAC consultants should be addressed concerning noise level and initial cost of the system; and top managers are most interested in whether the technology is state-of-the-art. Knowing the criteria of key buying center participants has significant operational value to the marketer when designing new products and when developing and targeting advertising and personal selling presentations. 46 McQuiston and Dickson, “The Effect of Perceived Personal Consequences on Participation and Influence in Organizational Buying,” pp. 159–177. 47 Jagdish N. Sheth, “A Model of Industrial Buyer Behavior,” Journal of Marketing 37 (October 1973): p. 51; see also Sheth, “Organizational Buying Behavior: Past Performance and Future Expectations,” Journal of Business & Industrial Marketing 11 (3/4, 1996): pp. 7–24. 48 Sheth, “A Model of Industrial Buyer Behavior,” pp. 52–54. 49 Jean-Marie Choffray and Gary L. Lilien, “Assessing Response to Industrial Marketing Strategy,” Journal of Marketing 42 (April 1978): pp. 20–31. For related research, see R. Venkatesh, Ajay K. Kohli, and Gerald Zaltman, “Influence Strategies in Buying Centers,” Journal of Marketing 59 (October 1995): pp. 71–82; and Mark A. Farrell and Bill Schroder, “Influence Strategies in Organizational Buying Decisions,” Industrial Marketing Management 25 (July 1996): pp. 293–303. Chapter 3 Organizational Buying Behavior 83 Information Processing Volumes of information flow into every organization through direct-mail advertising, the Internet, journal advertising, trade news, word of mouth, and personal sales presentations. What an individual organizational buyer chooses to pay attention to, comprehend, and retain has an important bearing on procurement decisions. Selective Processes Information processing is generally encompassed in the broader term cognition, which U. Neisser defines as “all the processes by which the sensory input is transformed, reduced, elaborated, stored, recovered, and used.”50 Important to an individual’s cognitive structure are the processes of selective exposure, attention, perception, and retention. 1. Selective exposure. Individuals tend to accept communication messages consistent with their existing attitudes and beliefs. For this reason, a purchasing agent chooses to talk to some salespersons and not to others. 2. Selective attention. Individuals filter or screen incoming stimuli to admit only certain ones to cognition. Thus, an organizational buyer is more likely to notice a trade advertisement that is consistent with his or her needs and values. 3. Selective perception. Individuals tend to interpret stimuli in terms of their existing attitudes and beliefs. This explains why organizational buyers may modify or distort a salesperson’s message in order to make it more consistent with their predispositions toward the company. 4. Selective retention. Individuals tend to recall only information pertinent to their own needs and dispositions. An organizational buyer may retain information concerning a particular brand because it matches his or her criteria. Each of these selective processes influences the way an individual decision maker responds to marketing stimuli. Because the procurement process often spans several months and because the marketer’s contact with the buying organization is infrequent, marketing communications must be carefully designed and targeted.51 Key decision makers “tune out” or immediately forget poorly conceived messages. They retain messages they deem important to achieving goals. Risk-Reduction Strategies Individuals are motivated by a strong desire to reduce risk in purchase decisions. Perceived risk includes two components: (1) uncertainty about the outcome of a decision and (2) the magnitude of consequences from making the wrong choice. Research highlights the importance of perceived risk and the purchase type in shaping the structure of the decision-making unit.52 Individual decision making is likely to occur in organizational buying for straight rebuys and for modified rebuys when the perceived risk is low. In these situations, the purchasing agent may initiate action.53 Modified rebuys of higher risk and new tasks seem to spawn a group structure. 50 U. Neisser, Cognitive Psychology (New York: Appleton, 1966), p. 4. 51 See, for example, Brent M. Wren and James T. Simpson, “A Dyadic Model of Relationships in Organizational Buying: A Synthesis of Research Results,” Journal of Business & Industrial Marketing 11 (3/4, 1996): pp. 68–79. 52 Elizabeth J. Wilson, Gary L. Lilien, and David T. Wilson, “Developing and Testing a Contingency Paradigm of Group Choice in Organizational Buying,” Journal of Marketing Research 28 (November 1991): pp. 452–466. 53 Sheth, “A Model of Industrial Buyer Behavior,” p. 54; see also W. E. Patton III, Charles P. Puto, and Ronald H. King, “Which Buying Decisions Are Made by Individuals and Not by Groups?” Industrial Marketing Management 15 (May 1986): pp. 129–138. 84 Part II Managing Relationships in Business Marketing B2B TOP PERFORMERS Delivering Customer Solutions If you review the performance of salespersons at most business marketing firms, large or small, you will observe some who consistently perform at a level that sets them apart from their peers. A recent study explores how exceptional performers acquire and use information to manage customer relationships. In-depth interviews were conducted with 60 salespersons at a Fortune 500 firm: 20 high-performing, 20 average-performing, and 20 low-performing salespersons. Sharp differences emerged when the salespersons were asked to categorize their customers into groups based on characteristics they found most useful in managing customer relationships. Here high performers emphasize customer goals, whereas low performers emphasize customer demographics (for example, large versus small firms). In turn, the study reveals that high performers develop a more extensive network of relationships within the customer organization compared with their colleagues. Importantly, high performers are better able to establish and maintain profitable customer relationships because they align their organization’s special capabilities to the customer’s primary goals. In other words, top-performing sales specialists provide a solution that advances the performance of the customer organization. SOURCE: Gabriel R. Gonzalez, Beth A. Walker, Dimitrios Kapelianis, and Michael D. Hutt, “The Role of Information Acquisition and Knowledge Use in Managing Customer Relationships,” working paper, Arizona State University, Tempe, Ariz., 2008. In confronting “risky” purchase decisions, how do organizational buyers behave? As the risk associated with an organizational purchase decision increases, the following occur54: • The buying center becomes larger and comprises members with high levels of organizational status and authority. • The information search is active and a wide variety of information sources are consulted. As the decision process unfolds, personal information sources (for example, discussions with managers at other organizations that have made similar purchases) become more important. • Buying center participants invest greater effort and deliberate more carefully throughout the purchase process. • Sellers who have a proven track record with the firm are favored—the choice of a familiar supplier helps reduce perceived risk. Rather than price, product quality and after-sale service are typically most important to organizational buyers when they confront risky decisions. When introducing new products, entering new markets, or approaching new customers, the marketing strategist should evaluate the effect of alternative strategies on perceived risk. 54 Johnston and Lewin, “Organizational Buying Behavior: Toward an Integrative Framework,” pp. 8–10. See also Puto, Patton, and King, “Risk Handling Strategies in Industrial Vendor Selection Decisions,” pp. 89–95. Chapter 3 FIGURE 3.4 Organizational Buying Behavior 85 MAJOR ELEMENTS OF ORGANIZATIONAL BUYING BEHAVIOR Evoked Set of Alternatives Individual Responsibilities Comprising the Buying Center Environmental Constraints (Physical, Technological, Economic, Social) Organizational Requirements (Technical, Financial) Sources of Information Evaluation Criteria Interaction Structure Feasible Set of Alternatives Formation of Individual Preferences Formation of Organizational Preferences Organizational Choice SOURCE: Jean-Marie Choffray and Gary L. Lilien, “Assessing Response to Industrial Marketing Strategy,” Journal of Marketing 42 (April 1978): p. 22. Reprinted by permission of the American Marketing Association. The Organizational Buying Process: Major Elements The behavior of organizational buyers is influenced by environmental, organizational, group, and individual factors. Each of these spheres of influence has been discussed in an organizational buying context, with particular attention to how the industrial marketer should interpret these forces and, more important, factor them directly into marketing strategy planning. A model of the organizational buying process is presented in Figure 3.4, which serves to reinforce and integrate the key areas discussed so far in this chapter.55 55 Choffray and Lilien, “Assessing the Response to Industrial Marketing Strategy,” pp. 20–31. Other models of organizational buying behavior include Webster and Wind, Organizational Buying Behavior, pp. 28–37; and Sheth, “A Model of Industrial Buyer Behavior,” pp. 50–56. For a comprehensive review, see Sheth, “Organizational Buying Behavior,” pp. 7–24; and Johnston and Lewin, “Organizational Buying Behavior,” pp. 1–15. 86 Part II Managing Relationships in Business Marketing This framework focuses on the relationship between an organization’s buying center and the three major stages in the individual purchase decision process: 1. the screening of alternatives that do not meet organizational requirements; 2. the formation of decision participants’ preferences; 3. the formation of organizational preferences. Observe that individual members of the buying center use various evaluative criteria and are exposed to various sources of information, which influence the industrial brands included in the buyer’s evoked set of alternatives—the alternative brands a buyer calls to mind when a need arises and that represent only a few of the many brands available.56 Environmental constraints and organizational requirements influence the procurement process by limiting the number of product alternatives that satisfy organizational needs. For example, capital equipment alternatives that exceed a particular cost (initial or operating) may be eliminated from further consideration. The remaining brands become the feasible set of alternatives for the organization, from which individual preferences are defined. The interaction structure of the members of the buying center, who have differing criteria and responsibilities, leads to the formation of organizational preferences and ultimately to organizational choice. Understanding the organizational buying process enables the marketer to play an active rather than a passive role in stimulating market response. The marketer who identifies organizational screening requirements and the salient evaluative criteria of individual buying center members can make more informed product design, pricing, and promotional decisions. Summary Knowledge of the process that organizational buyers follow in making purchasing decisions is fundamental to responsive marketing strategy. As a buying organization moves from the problem-recognition phase, in which a procurement need is defined, to later phases, in which suppliers are screened and ultimately chosen, the marketer can play an active role. In fact, the astute marketer often triggers initial awareness of the problem and helps the organization effectively solve that problem. Incremental decisions made throughout the buying process narrow the field of acceptable suppliers and dramatically influence the ultimate outcome. The nature of the buying process depends on the organization’s level of experience with similar procurement problems. It is thus crucial to know how the organization defines the buying situation: as a new task, a modified rebuy, or a straight rebuy. Each buying situation requires a unique problem-solving approach, involves unique buying influentials, and demands a unique marketing response. 56 Howard and Sheth, The Theory of Buyer Behavior, p. 26; see also Ronald P. LeBlanc, “Environmental Impact on Purchase Decision Structure,” Journal of Purchasing and Materials Management 17 (Spring 1981): pp. 30–36; and Lowell E. Crow, Richard W. Olshavsky, and John O. Summers, “Industrial Buyers’ Choice Strategies: A Protocol Analysis,” Journal of Marketing Research 17 (February 1980): pp. 34–44. Chapter 3 Organizational Buying Behavior 87 Myriad forces—environmental, organizational, group, and individual—influence organizational buying behavior. First, environmental forces define the boundaries within which industrial buyers and sellers interact, such as general business conditions or the rate of technological change. Second, organizational forces dictate the link between buying activities and the strategic priorities of the firm and the position that the purchasing function occupies in the organizational structure. Third, the relevant unit of analysis for the marketing strategist is the buying center. The composition of this group evolves during the buying process, varies from firm to firm, and changes from one purchasing situation to another. Fourth, the marketer must ultimately concentrate attention on individual members of the buying center. Each brings a particular set of experiences and a unique personal and organizational frame of reference to the buying decision. The marketer who is sensitive to individual differences is best equipped to develop responsive marketing communications that the organizational buyer will remember. Unraveling the complex forces that encircle the organizational buying process is indeed difficult. This chapter offers a framework that enables the marketing manager to begin this task by asking the right questions. The answers provide the basis for effective and efficient business marketing strategy. Discussion Questions 1. Ford revamped the way it purchases operating resources such as office, computer, and maintenance supplies. Instead of having employees fill out purchase orders that must be cleared by the boss days later, employees simply log on to an Internet system. They browse through the electronics catalogs of manufacturers, order from a preapproved group of suppliers, and get purchase approval in minutes. What new challenges and opportunities does the e-procurement system present for business marketers who serve Ford? 2. Jim Jackson, an industrial salesperson for Pittsburgh Machine Tool, will call on two accounts this afternoon. The first will be a buying organization Jim has been servicing for the past 3 years. The second call, however, poses more of a challenge. This buying organization has been dealing with a prime competitor of Pittsburgh Machine Tool for 5 years. Jim, who has good rapport with the purchasing and engineering departments, feels that the time may be right to penetrate this account. Recently, Jim learned that the purchasing manager was extremely unhappy with the existing supplier’s poor delivery service. Define the buying situations confronting Jim and outline the appropriate strategy he should follow in each case. 3. Karen Weber, the purchasing agent for Smith Manufacturing, views the purchase of widgets as a routine buying decision. What factors might lead her to alter this position? More important, what factors determine whether Karen considers a particular supplier, such as Albany Widget? 4. Harley-Davidson, the U.S. motorcycle producer, recently purchased some sophisticated manufacturing equipment to enhance its position in a very competitive market. First, what environmental forces might have been important in spawning this capital investment? Second, which functional units were likely to have been represented in the buying center? 88 Part II Managing Relationships in Business Marketing 5. Brunswick Corporation centralizes its procurement decisions at the headquarters level. Discuss how it would approach purchasing differently than a competitor that decentralizes purchasing across various plant locations. 6. The Kraus Toy Company recently decided to develop a new electronic game. Can an electrical parts supplier predict the likely composition of the buying center at Kraus Toy? What steps could an industrial salesperson take to influence the composition of the buying center? 7. Explain how the composition of the buying center evolves during the purchasing process and how it varies from one firm to another, as well as from one purchasing situation to another. What steps can a salesperson take to identify the influential members of the buying center? 8. Carol Brooks, purchasing manager for Apex Manufacturing Co., read the Wall Street Journal this morning and carefully studied, clipped, and saved a full-page ad by the Allen-Bradley Company. Ralph Thornton, the production manager at Apex, read several articles from the same paper but could not recall seeing this particular ad or, for that matter, any ads. How could this occur? 9. Organizations purchase millions of notebook computers each year. Identify several evaluative criteria that purchasing managers might use in choosing a particular brand. In your view, which criteria would be most decisive in the buying decision? 10. The levels of risk associated with organizational purchases range from low to high. Discuss how the buying process for a risky purchase differs from the process for a routine purchase. Internet Exercises 1. Dell, Inc., has been wildly successful in selling its products over the Internet to customers of all types, including every category of customers in the business market: commercial enterprises, institutions, and government. Assume your university library is planning to purchase 25 new desktop computers. Go to http://www.dell.com and to the Dell Online Store for Higher Education and: a. identify the price and product dimensions of two desktop systems that might meet your university’s needs, and b. provide a critique of the Web site and consider how well it provided access to the information that a potential buyer might want. CASE The Tablet PC for Nurses: A Mobile Clinical Assistant57 Intel Corporation and Motion Computing, Inc., are demonstrating the result of a joint effort to increase the productivity of nurses—the Motion C5 Mobile Clinical Assistant—a tablet-style personal computer designed for use in hospitals and clinics. The idea for the product emerged from ethnographic studies that Intel conducted in the health-care setting. Here researchers observed the round-the-clock flow of activities in a hospital and meticulously recorded the key tasks performed by the nurses and professional staff, tracing their every movement. The C5 benefited from the rich insights uncovered by Intel’s study as well as from similar research that Motion Computing had completed in prior years. The companies believe that the device will help nurses handle chores such as remotely calling up medical records and doctors’ orders, charting vital signs, and exchanging information with other professionals. The Motion C5, which is priced at $2,199, provides a sure-grip handle, a sealed case for easy cleaning and disinfecting, a lightweight design for portability, a 10-inch screen for easily viewing clinical information, rugged construction, and a pen and stylus input so clinicians can enter text and navigate the software without being tied to a keyboard. The innovative device also incorporates such features as integrated bar code and radio frequency identification (RFID) readers for patient identification and/ or electronic medication administration, an integrated camera, and built-in wireless connectivity. When the Motion C5 was released in 2007, about 16 percent of U.S. hospitals were using tablet PCs, and 24 percent had smaller handheld computers. Some hospitals prefer what they call COWs—computers on wheels—that can be rolled into patients’ rooms. One of the first U.S. adopters of the Motion C5 was Island Hospital, located in Anacortes, Washington. Rick Kiser, assistant director of information systems for Island Hospital, was centrally involved in the buying decision. Though Island’s buying team had initially recommended adding COWs for every patient room, the nursing staff had concerns about COWs’ limitations. Kiser noted: “The single biggest issue was the COWs are impossible to clean. The sanitary aspect was a nightmare.” Holly Hoskinson, RN and clinical infomatics specialist, also noted the COWs were difficult to maneuver from room to room. “We tried a variety of cart styles but they are all still big and heavy.” Another Island RN, Chris Storm, agreed: “We wanted a device in each room and based on our budget we would have to move COWs from room to room. That option was not acceptable.” While other brands of PC tablets were evaluated, the buying team determined that the Motion C5 best met Island’s needs. Concerning the decision, Rick Kiser observed: “The thing that cinched it was that this tablet was designed for the medical environment. They are drop resistant and easy to clean and other tablets didn’t offer anything near what we needed.” 57 “The Three M’s: Mobility, MEDITECH, and Motion C5,” White paper, February 2008, Motion Computing, Inc., accessed at http://www.motioncomputing.com on June 5, 2008; and Don Clark, “Intel, Motion Develop Tablet PC for Nurses,” Wall Street Journal, February 21, 2007, p. D7. 89 90 Part II Managing Relationships in Business Marketing Discussion Questions 1. Suggest strategies that Motion Computing might follow to speed the adoption of the Motion C5 device by hospitals. 2. Potential members of the buying center for a tablet PC purchasing decision might include hospital administrators, nurses, doctors, information technology (IT) specialists, and purchasing managers. Describe how the buying criteria emphasized by hospital administrators or purchasing managers might differ from those embraced by IT specialists or members of the medical staff. CHAPTER 4 Customer Relationship Management Strategies for Business Markets A well-developed ability to create and sustain successful working relationships with customers gives business marketing firms a significant competitive advantage. After reading this chapter, you will understand: 1. the patterns of buyer-seller relationships in the business market. 2. the factors that influence the profitability of individual customers. 3. a procedure for designing effective customer relationship management strategies. 4. the distinctive capabilities of firms that excel at customer relationship management. 5. the critical determinants of success in managing strategic alliances. 91 92 Part II Managing Relationships in Business Marketing Every night, John Chambers, CEO of Cisco Systems, receives a personal update on 15 to 20 major customers via voice-mail. “E-mail would be more efficient but I want to hear the emotion, I want to hear the frustration; I want to hear the caller’s level of comfort with the strategy we’re employing,” says Chambers. “I can’t get that through e-mail.”1 In addition to giving day-to-day attention to monitoring relationships with the firm’s most valuable customers, John Chambers has personally taken the lead in forging important strategic alliances.2 Leading business marketing firms like Cisco succeed by providing superior value to customers, by satisfying the special needs of even the most demanding customers, and by understanding the factors that influence individual customer profitability. Compared with the consumer packaged-goods sector, customer profitability is particularly important in business markets because marketing managers allocate a greater proportion of their marketing resources at the individual customer level.3 The ability of an organization to create and maintain profitable relationships with these most valuable customers is a durable basis of competitive advantage. A business marketer who wishes to find a place on Cisco’s preferred supplier list must be prepared to help the firm provide more value to its demanding customers. To this end, the marketer must provide exceptional performance in quality, delivery, and, over time, cost competitiveness. The supplier must also understand how Cisco measures value and how its product and service offering can meet or surpass these value expectations. Building and maintaining lasting customer relationships requires careful attention to detail, meeting promises, and swiftly responding to new requirements. The new era of business marketing is built upon effective relationship management.4 Many business marketing firms create what might be called a collaborative advantage by demonstrating special skills in managing relationships with key customers or by jointly developing innovative strategies with alliance partners.5 These firms have learned how to be good partners, and these superior relationship skills are a valuable asset. This chapter explores the types of relationships that characterize the business market. What market and situational factors are associated with different types of buyerseller relationships? What factors influence customer profitability? What strategies can business marketers employ to build profitable relationships with customers? What are the distinctive capabilities of firms that excel at customer relationship management and consistently deliver superior financial performance in managing strategic alliances? Relationship Marketing6 Relationship marketing centers on all activities directed toward establishing, developing, and maintaining successful exchanges with customers and other constituents.7 Nurturing and managing customer relationships have emerged as an important 1 Frederick E. Reichheld, “Lead for Loyalty,” Harvard Business Review 79 (July–August 2001): p. 82. 2 “Cisco: Perspective on Strategic Alliances: An Interview with Greg Fox, Director of Marketing for Cisco’s Strategic Alliances,” Leading Edge Newsletter, Volume 1, No. 5 (May 2006), accessed at http://www.amanet.org on July 5, 2008. 3 Douglas Bowman and Das Narayandas, “Linking Customer Management Effort to Customer Profitability in Business Markets,” Journal of Marketing Research 41 (November 2004): pp. 433–447. 4 For a comprehensive review, see Robert W. Palmatier, Relationship Marketing (Boston: Marketing Science Institute, 2008). 5 Rosabeth Moss Kanter, “Collaborative Advantage,” Harvard Business Review 72 (July–August 1994): pp. 96–108. 6 This section is based on George S. Day, “Managing Market Relationships,” Journal of the Academy of Marketing Science 28 (Winter 2000): pp. 24–30, except when others are cited. 7 Robert M. Morgan and Shelby D. Hunt, “The Commitment-Trust Theory of Relationship Marketing,” Journal of Marketing 58 (July 1994): pp. 20–38. Chapter 4 FIGURE 4.1 Customer Relationship Management Strategies for Business Markets 93 THE RELATIONSHIP SPECTRUM Transactional Exchanges Anonymous transactions/ Automated purchasing Value-Added Exchanges Collaborative Exchanges Complete collaboration and integration of supplier with customer or channel partner SOURCE: Figure from “Managing Market Relationships” by George S. Day from Journal of Academy of Marketing Science 28 (Winter 2000): p. 25. Copyright © 2000. Reprinted by permission of Springer. strategic priority in most firms. Why? First, loyal customers are far more profitable than customers who are price sensitive and perceive few differences among alternative offerings. Second, a firm that is successful in developing strong relationships with customers secures important and durable advantages that are hard for competitors to understand, copy, or displace. Types of Relationships A business marketer may begin a relationship with GE as a supplier (one of many), move to a preferred supplier status (one of a few), and ultimately enter a collaborative relationship with GE (sole source for particular items). Observe in Figure 4.1 that buyer-seller relationships are positioned on a continuum, with transactional exchange and collaborative exchange serving as the endpoints. Central to every relationship is an exchange process where each side gives something in return for a payoff of greater value. Transactional exchange centers on the timely exchange of basic products for highly competitive market prices. George Day notes that such exchanges include the kind of autonomous encounters a visitor to a city has with the taxi or bus from the airport, as well as a series of ongoing transactions in a businessto-business market where the customer and supplier focus only on the timely exchange of standard products at competitive prices.8 Moving across the continuum, relationships become closer or more collaborative. The open exchange of information is a characteristic of collaborative (close) versus transactional (distant) exchange. Likewise, operational linkages reflect how much the systems, procedures, and routines of the buying and selling firms have been connected to facilitate operations.9 These relationship connectors are a feature of a collaborative relationship. For example, such linkages provide the basis for order replenishment or just-in-time deliveries that Honda receives each day from suppliers at its Marysville, Ohio, production facility. Collaborative exchange features very close information, social, and operational linkages as well as mutual commitments 8 Day, “Managing Market Relationships,” p. 25. 9 Joseph P. Cannon and William D. Perreault, Jr., “Buyer-Seller Relationships in Business Markets,” Journal of Marketing Research 36 (November 1999): pp. 439–460. 94 Part II Managing Relationships in Business Marketing made in expectation of long-run benefits. According to James Anderson and James Narus, collaborative exchange involves a process where a customer and supplier firm form strong and extensive social, economic, service, and technical ties over time, with the intent of lowering total costs and/or increasing value, thereby achieving mutual benefit.10 Value-Adding Exchanges Between the two extremes on the relationship continuum are value-adding exchanges, where the focus of the selling firm shifts from attracting customers to keeping customers. The marketer pursues this objective by developing a comprehensive understanding of a customer’s needs and changing requirements, tailoring the firm’s offerings to those needs, and providing continuing incentives for customers to concentrate most of their purchases with them. To illustrate, W.W. Grainger provides a customized Web page for each of its premier corporate customers that individual employees in the customer organization can use to track expenditures on maintenance and operating supplies against key performance benchmarks. Nature of Relationships Transactional exchange involves items like packaging materials or cleaning services where competitive bidding is often employed to secure the best terms. Such exchanges are purely contractual arrangements that involve little or no emotional commitment to sustaining the relationship in the future. By contrast, customized, high-technology products—like semiconductor test equipment—fit the collaborative exchange category. Whereas transactional exchange centers on negotiations and an arm’s-length relationship, collaborative exchange emphasizes joint problem solving and multiple linkages that integrate the processes of the two parties. Trust and commitment provide the foundation for collaborative exchange.11 Relationship commitment involves a partner’s belief that an ongoing relationship is so important that it deserves maximum efforts to maintain it. In turn, trust exists when one party has confidence in a partner’s reliability and integrity. Recent research highlights the powerful role that contact personnel (for example, salespersons) assume in forging a long-term relationship. “Individuals who build trust in each other will transfer this bond to the firm level.”12 Strategic Choices Business marketers have some latitude in choosing where to participate along the relationship continuum. However, limits are imposed by the characteristics of the 10 James C. Anderson and James A Narus, “Partnering as a Focused Market Strategy,” California Management Review 33 (Spring 1991): p. 96. See also Ven Srivam, Robert Krapfel, and Robert Spekman, “Antecedents to Buyer-Seller Collaboration: An Analysis from the Buyer’s Perspective,” Journal of Business Research (December 1992): pp. 303–320. 11 Morgan and Hunt, “The Commitment-Trust Theory,” pp. 20–38. See also Patricia M. Doney and Joseph P. Cannon, “An Examination of the Nature of Trust in Buyer-Seller Relationships,” Journal of Marketing 61 (April 1997): pp. 35–51. 12 Das Narayandas and V. Kasturi Rangan, “Building and Sustaining Buyer-Seller Relationships in Mature Industrial Markets,” Journal of Marketing 68 (July 2004): p. 74; and Robert W. Palmatier, Lisa K. Scheer, and Jan-Benedict E. M. Steenkamp, “Customer Loyalty to Whom? Managing the Benefits and Risks of Salesperson-Owned Loyalty,” Journal of Marketing Research 44 (May 2007): pp. 185–199. Chapter 4 Customer Relationship Management Strategies for Business Markets 95 B2B TOP PERFORMERS Understanding the Customer’s Business—The Key to Success To forge a collaborative relationship with a customer, the business marketer requires a deep understanding of the customer’s business, its key competitors, and its goals and strategies. In turn, a wealth of communication links are required across the partnering organizations at all levels of management. Salespersons not only work with the purchasing staff but also have close ties to senior executives. For example, for some of IBM’s Fortune 500 customers, account executives are direct participants in the customer firm’s strategy planning sessions. Here IBM adds value to the relationship by providing specific recommendations concerning how its products and services can be used to advance the firm’s competitive advantage. As a relationship with a large account grows and flourishes, a full-time sales team is often created to serve the needs of that customer. The team comprises sales, service, and technical specialists who have extensive knowledge of the customer’s industry. Some team members have worked exclusively with a single customer organization for years. market and by the significance of the purchase to the buyer. A central challenge for the marketer is to overcome the gravitational pull toward the transaction end of the exchange spectrum. According to Day, Rivals are continually working to attract the best accounts away; customer requirements, expectations, and preferences keep changing, and the possibility of friction-free exploration of options in real time on the Web conspire to raise the rate of customer defections.13 Managing Buyer-Seller Relationships Buyers and sellers craft different types of relationships in response to market conditions and the characteristics of the purchase situation. To develop specific relationshipmarketing strategies for a particular customer, the business marketer must understand that some customers elect a collaborative relationship, whereas others prefer a more distant or transactional relationship. Figure 4.2 highlights the typical characteristics of relationships at the endpoints of the buyer-seller relationship spectrum. Transactional Exchange Customers are more likely to prefer a transactional relationship when a competitive supply market features many alternatives, the purchase decision is not complex, and the supply market is stable. This profile fits some buyers of office supplies, commodity chemicals, and shipping services. In turn, customers emphasize a transactional orientation when they view the purchase as less important to the organization’s objectives. Such relationships are characterized by lower levels of information exchange and are less likely to involve operational linkages between the buying and selling firms. 13 Day, “Managing Market Relationships,” p. 25. 96 Part II Managing Relationships in Business Marketing FIGURE 4.2 THE SPECTRUM OF BUYER-SELLER RELATIONSHIPS Transactional Exchange Collaborative Exchange Availability of Alternatives Many Alternatives Few Alternatives Supply Market Dynamism Stable Volatile Importance of Purchase Low High Complexity of Purchase Low High Information Exchange Low High Operational Linkages Limited Extensive SOURCE: Adapted from Joseph P. Cannon and William D. Perreault Jr., “Buyer-Seller Relationships in Business Markets,” Journal of Marketing Research 36 (November 1999): pp. 439–460. Collaborative Exchange Buying firms prefer a more collaborative relationship when alternatives are few, the market is dynamic (for example, rapidly changing technology), and the complexity of the purchase is high. In particular, buyers seek close relationships with suppliers when they deem the purchase important and strategically significant. This behavior fits some purchasers of manufacturing equipment, enterprise software, or critical component parts. Indeed, say Cannon and Perreault, the closest partnerships . . . arise both when the purchase is important and when there is a need—from the customer’s perspective—to overcome procurement obstacles that result from fewer supply alternatives and more purchase uncertainty.14 Moreover, the relationships that arise for important purchases are more likely to involve operational linkages and high levels of information exchange. Switching costs are especially important to collaborative customers. Switching Costs In considering possible changes from one selling firm to another, organizational buyers consider two switching costs: investments and risk of exposure. First, organizational buyers invest in their relationships with suppliers in many ways. As Barbara Bund Jackson states: They invest money; they invest in people, as in training employees to run new equipment; they invest in lasting assets, such as equipment itself; and they invest in changing basic business procedures like inventory handling. 15 14 Cannon and Perreault, “Buyer-Seller Relationships,” p. 453. 15 Barbara Bund Jackson, “Build Customer Relationships That Last,” Harvard Business Review 63 (November–December 1985): p. 125. Chapter 4 Customer Relationship Management Strategies for Business Markets 97 Because of these past investments, buyers may hesitate to incur the disruptions and switching costs that result when they select new suppliers. Risk of exposure provides a second major category of switching costs. Attention centers on the risks to buyers of making the wrong choice. Customers perceive more risk when they purchase products important to their operations, when they buy from less established suppliers, and when they buy technically complex products. Strategy Guidelines The business marketer manages a portfolio of relationships with customers—some of these customers view the purchase as important and desire a close, tightly connected buyer-seller relationship; other customers assign a lower level of importance to the purchase and prefer a looser relationship. Given the differing needs and orientations of customers, the business marketer’s first step is to determine which type of relationship matches the purchasing situation and supply-market conditions for a particular customer. Second, a strategy must be designed that is appropriate for each strategy type. Collaborative Customers Relationship-building strategies, targeted on strong and lasting commitments, are especially appropriate for these customers. Business marketers can sensibly invest resources to secure commitments and directly assist customers with planning. Here sales and service personnel work not only with purchasing managers but also with a wide array of managers on strategy and coordination issues. Regular visits to the customer by executives and technical personnel can strengthen the relationship. Operational linkages and information-sharing mechanisms should be designed into the relationship to keep product and service offerings aligned with customer needs. Given the long time horizon and switching costs, customers are concerned both with the marketers’ long-term capabilities and with their immediate performance. Because the customers perceive significant risk, they demand competence and commitment from sellers and are easily frightened by even a hint of supplier inadequacy. Value Drivers in Collaborative Relationships A recent study examined this intriguing question: What avenues of differentiation can suppliers of routinely purchased products use to create value in business-to-business relationships, thereby winning key supplier status?16 From Table 4.1, observe that the study uncovered three sources of value creation—value creation through the core offering, within the sourcing process, and at the level of the customer’s operations. The associated relationship benefits and costs for each are listed. Consistent with the total cost of ownership (Chapter 2) perspective that purchasing managers apply, costs as a value driver center on the degree to which the supplier offers a lower price or adds value by taking costs out of the sourcing process or the customer’s operations. The results suggest that relationship benefits display a much stronger potential for differentiation in key supplier relationships than cost considerations. Importantly, service support and personal interaction were identified as the core differentiators, 16 Wolfgang Ulaga and Andreas Eggert, “Value-Based Differentiation in Business Relationships: Gaining and Sustaining Key Supplier Status,” Journal of Marketing 70 (January 2006): pp. 119–136. 98 Part II Managing Relationships in Business Marketing TABLE 4.1 VALUE DRIVERS IN KEY SUPPLIER RELATIONSHIPS Sources of Value Creation Core offering Sourcing process Customer operations Relationship Value Dimensions Costs Benefits Product quality Delivery performance Service support Personal interaction Supplier know-how Time to market Direct costs Acquisition costs Operation costs SOURCE: Wolfgang Ulaga and Andreas Eggert, “Value-Based Differentiation in Business Relationships: Gaining and Sustaining Key Supplier Status,” Journal of Marketing 70 ( January 2006): p. 122. Copyright © 2001. Reprinted by permission of Warren, Gorham, Lamont via Copyright Clearance Center. followed by a supplier’s know-how and its ability to improve a customer’s time to market. Product quality and delivery performance, along with cost savings associated with the acquisition process and from operations, display a moderate potential to help a firm gain key supplier status. Finally, price displayed the weakest potential for differentiation. The researchers, Wolfgang Ulaga and Andreas Eggert, conclude: “Whereas cost factors serve as key criteria to get a supplier on the short list of those vendors considered for a relationship, relationship benefits dominate when deciding which supplier” should be awarded key supplier status.17 Transaction Customers These customers display less loyalty or commitment to a particular supplier and can easily switch part or all of the purchases from one vendor to another. A business marketer who offers an immediate, attractive combination of product, price, technical support, and other benefits has a chance of winning business from a transactional customer. The salesperson centers primary attention on the purchasing staff and seldom has important ties to senior executives in the buying organization. M. Bensaou argues that it is unwise for marketers to make specialized investments in transactional relationships: Firms that invest in building trust through frequent visits, guest engineers, and cross-company teams when the product and market context calls for simple, impersonal control and data exchange mechanisms are overdesigning the relationship. This path is not only costly but also risky, given the specialized investments involved, in particular, the intangible ones (for example, people, information, or knowledge).18 Rather than adopting the approach of “one design fits all,” the astute marketer matches the strategy to the product and market conditions that surround a particular customer relationship and understands the factors that influence profitability. 17 Ibid., p. 131. 18 M. Bensaou, “Portfolio of Buyer-Seller Relationships,” Sloan Management Review 40 (Summer 1999): p. 43. Chapter 4 Customer Relationship Management Strategies for Business Markets 99 Measuring Customer Profitability19 To improve customer satisfaction and loyalty, many business-to-business firms have developed customized products and increased the specialized services they offer. Although customers embrace such actions, they often lead to declining profits, especially when the enhanced offerings are not accompanied by increases in prices or order volumes. For a differentiation strategy to succeed, “the value created by the differentiation—measured by higher margins and higher sales volumes—has to exceed the cost of creating and delivering customized features and services.”20 By understanding the drivers of customer profitability, the business marketing manager can more effectively allocate marketing resources and take action to convert unprofitable relationships into profitable ones. Activity-Based Costing Most studies of customer profitability yield a remarkable insight: “Only a minority of a typical company’s customers is truly profitable.”21 Why? Many firms fail to examine how the costs of specialized products and services vary among individual customers. In other words, they focus on profitability at an aggregate level (for example, product or territory), fail to assign operating expenses to customers, and misjudge the profitability of individual customers. To capture customer-specific costs, many firms have adopted activity-based costing. Activity-based costing (ABC) illuminates exactly what activities are associated with serving a particular customer and how these activities are linked to revenues and the consumption of resources.22 The ABC system and associated software link customer transaction data from customer relationship management (CRM) systems with financial information. The ABC system provides marketing managers with a clear and accurate picture of the gross margins and cost-to-serve components that yield individual customer profitability. Unlocking Customer Profitability By accurately tracing costs to individual customers, managers are better equipped to diagnose problems and take appropriate action. For example, Kanthal, a heating wire manufacturer, learned to its surprise that one of its largest and most coveted accounts—General Electric’s Appliance Division—was also one of its most unprofitable customers.23 A customer order that normally would cost Kanthal $150 to process cost more than $600 from GE because of frequent order changes, expedited deliveries, and scheduling adjustments. A senior manager at Kanthal suggested to GE that the numerous change orders were costly not only to Kanthal but also to GE. After a quick internal review, GE managers agreed, corrected internal inefficiencies, and then 19 This section, unless otherwise noted, draws on Robert S. Kaplan and V. G. Narayanan, “Measuring and Managing Customer Profitability,” Journal of Cost Management 15 (5, September–October 2001): pp. 5–15. 20 Robert S. Kaplan, “Add a Customer Profitability Metric to Your Balanced Scorecard,” Balanced Scorecard Report, July–August 2005 (Boston: Harvard Business School Publishing Corporation), p. 3. 21 Kaplan and Narayanan, “Measuring and Managing Customer Profitability,” p. 5. 22 Ibid., p. 7. See also Robert S. Kaplan and Steven R. Anderson, “Time-Driven Activity-Based Costing,” Harvard Business Review 82 (November 2004): pp. 131–138. 23 Kaplan and Narayanan, p. 11. 100 Part II Managing Relationships in Business Marketing Text not available due to copyright restrictions awarded Kanthal with the largest contract in the firm’s history. The contract incorporated a surcharge for any change GE made to an existing order and established a minimum order size. By isolating the true cost of serving GE, Kanthal converted an unprofitable relationship to a profitable one and provided further value by helping a key customer reduce costs. The Profitable Few Once a firm implements an ABC approach and plots cumulative profitability against customers, a striking portrait emerges that is often referred to as the whale curve (Figure 4.3). Robert S. Kaplan, who is codeveloper of activity-based costing, and his colleague, V. G. Narayanan, describe the pattern that many companies find: Whereas cumulative sales usually follow the typical 20/80 rule (that is, 20 percent of the customers provide 80 percent of the sales), the whale curve for cumulative profitability usually reveals that the most profitable 20 percent of customers generate between 150 percent and 300 percent of total profits. The middle 70 percent of customers break even and the least profitable 10 percent of customers lose from 50 to 200 percent of total profits, leaving the company with its 100 percent of total profits.24 24 Ibid., p. 7. See also Robert S. Kaplan and David P. Norton, The Execution Premium (Boston: Harvard Business Press, 2008), pp. 255–261. Chapter 4 Customer Relationship Management Strategies for Business Markets 101 Text not available due to copyright restrictions As a rule, large customers tend to be included among the most profitable (see left side of Figure 4.3) or the least profitable (see right side of Figure 4.3)—they are seldom in the middle. Interestingly, some of the firm’s largest customers often turn out to be among the most unprofitable. A firm does not generate enough sales volume with a small customer to incur large absolute losses. Only large buyers can be largeloss customers. In Figure 4.3, low-cost-to-serve customers appear on the profitable side of the whale curve and high-cost-to-serve customers end up on the unprofitable side unless they pay a premium price for the specialized support they require. Managing High- and Low-Cost-to-Serve Customers What causes some customers to be more expensive than others? Note from Table 4.2 that high-cost-to-serve customers, for example, desire customized products, frequently change orders, and require a significant amount of presales and postsales support. By contrast, low-cost-to-serve customers purchase standard products, place orders and schedule deliveries on a predictable cycle, and require little or no presales or postsales support. Look Inside First After reviewing the profitability of individual customers, the business marketer can consider possible strategies to retain the most valuable customers and to transform unprofitable customers into profitable ones. However, managers should first examine their company’s own internal processes to ensure that it can accommodate customer preferences for reduced order sizes or special services at the lowest cost. For example, a large publisher of business directories reduced the cost of serving its customer base by assigning key account managers to its largest customers (that is, the 4 percent of customers who accounted for 45 percent of its sales) Managing Relationships in Business Marketing CUSTOMER PROFITABILITY FIGURE 4.4 High Net Margin Realized 102 Part II Passive • Product is Crucial • Good Supplier Match Price Sensitive but Few Special Demands Costly to Service, but Pay Top Dollar its Prof es Loss Aggressive • Leverage Their Buying Power • Low Price and Lots of Customized Features Low Low High Cost-to-Serve SOURCE: Reprinted by permission of Harvard Business Review. From “Manage Customers for Profits (Not Just Sales)” by B. P. Shapiro et al., September–October 1987: p. 104. Copyright © 1987 by the Harvard Business School Publishing Corporation; all rights reserved. and serving the smallest customers over the Internet and by a telephone sales force.25 These actions not only cut costs dramatically but also gave each group of customers what they had wanted all along: Large customers wanted a central point of contact where they could secure services customized to their needs; small customers preferred minimal contact with a direct salesperson but wanted the assurance that they could receive advice and support if required. A Sharper Profit Lens Business marketing managers can view their customers through the lens of a simple 2 3 2 diagram (Figure 4.4). The vertical axis shows the net margin earned from sales to a particular customer. The net margin equals the net price, after all discounts, minus manufacturing costs. The horizontal axis shows the costs of serving the customer, including order-related costs plus the customerspecific marketing, technical, and administrative expenses. Identifying Profitable Customers Observe from Figure 4.4 that profitable customers can take different forms. To illustrate, a customer like Honda of America would be at the lower left corner of the diagram: demanding low prices, so net margins are low, but also working with its suppliers to streamline activities so that the cost-toserve is also low. High-cost-to-serve customers who occupy the upper right corner of Figure 4.4 can also be profitable if the net margins earned on sales to them more than compensate the company for the cost of the resources used in serving them. A company is indeed fortunate if several of its customers occupy the upper lefthand quadrant of the diagram: high margins and low cost-to-serve. Because these 25 George S. Day, “Creating a Superior Customer-Relating Capability,” MIT Sloan Management Review 44 (Spring 2003): pp. 77–82. Chapter 4 Customer Relationship Management Strategies for Business Markets 103 customers represent a valuable asset, marketing managers should forge close relationships with them, anticipate their changing needs, and have protective measures (for example, special services) in place in case competitors attempt to win them away. Managing Unprofitable Customers26 The most challenging set of customers for marketing managers is found in the lower right-hand corner of Figure 4.4: low margins and high cost-to-serve. First, the marketing manager should explore possible ways to reduce the cost of activities associated with serving these customers. For example, perhaps postsales support could be shifted to the Internet. Second, the manager should direct attention to the customer actions that contribute to higher selling costs. To illustrate, the high cost-to-serve may be caused by the customer’s unpredictable ordering patterns or by the large demands it places on technical and sales personnel. By detailing the costs of these activities and openly sharing this information with the customer, the business marketing manager can encourage the customer to work with the company more efficiently. From the earlier example, recall that Kanthal used this approach not only to restore profitability but also to help one of its largest customers, General Electric’s Appliance Division, refine its internal processes and reduce its costs. Firing Customers By improving processes and refining pricing strategies, business marketing managers can transform many, but not all, customers from unprofitable to profitable. What should we do with those unprofi table customers that remain in the highcost-to-serve quadrant of Figure 4.4? To answer this question, we have to dig deeper into the customer relationship and assess the other benefi ts that certain customers may provide. Some customers are new and the initial investment to attract them will ultimately be repaid in higher sales volume and profitability. Other customers provide an opportunity for learning. For example, some firms that serve Toyota or Honda incurred initial losses in serving these demanding customers but secured insights into management processes and technology they could effectively apply to all their customers. Suppose, however, that a customer is unprofitable, not new, and offers little or no opportunity for learning. Furthermore, suppose that the customer resists all attempts to convert the unprofitable relationship into a profitable one. Under these conditions, Robert S. Kaplan and Robin Cooper observe that we might consider firing them, but a more subtle approach will do: “We can, perhaps, let the customer fire itself by refusing to grant discounts and reducing or eliminating marketing and technical support.”27 Customer divestment is a viable strategic option, but one that must be exercised sparingly and only after other options have been thoroughly examined.28 26 This section is based on Robert S. Kaplan and Robin Cooper, Cost and Effect: Using Integrated Cost Systems to Drive Profitability and Performance (Boston: Harvard Business School Press, 1998), pp. 193–201. 27 Ibid., p. 200. 28 Vikas Mittal, Matthew Sarkees, and Feisal Murshed, “The Right Way to Manage Unprofitable Customers,” Harvard Business Review 86 (April 2008): pp. 95–102. 104 Part II Managing Relationships in Business Marketing Customer Relationship Management Customer retention has always been crucial to success in the business market, and it now provides the centerpiece of strategy discussions as firms embrace customer relationship management. Customer relationship management (CRM) is a crossfunctional process for achieving • a continuing dialogue with customers • across all their contact and access points, with • personalized treatment of the most valuable customers, • to ensure customer retention and the effectiveness of marketing initiatives.29 To meet these challenging requirements, business marketing firms, large and small, are making substantial investments in CRM systems—enterprise software applications that integrate sales, marketing, and customer service information. To improve service and retain customers, CRM systems synthesize information from all of a company’s contact points or “touch points”—including e-mail, call centers, sales and service representatives—to support later customer interactions and to inform market forecasts, product design, and supply chain management.30 Salespersons, call center personnel, Web managers, resellers, and customer service representatives all have the same real-time information on each customer. For an investment in CRM software to yield positive returns, a firm needs a customer strategy. Strategy experts contend that many CRM initiatives fail because executives mistake CRM software for a marketing strategy. Darrell Rigby and his colleagues contend: “It isn’t. CRM is the bundling of customer strategy and processes, supported by relevant software, for the purpose of improving customer loyalty and, eventually, corporate profitability.”31 CRM software can help, but only after a customer strategy has been designed and executed. To develop responsive and profitable customer strategies, special attention must be given to five areas: (1) acquiring the right customers, (2) crafting the right value proposition, (3) instituting the best processes, (4) motivating employees, and (5) learning to retain customers (Table 4.3). Observe how CRM technology from leading producers such as Oracle Corporation and Siebel Systems can be used to capture critical customer data, transform it into valuable information, and distribute it throughout the organization to support the strategy process from customer acquisition to customer retention. Thus, a well-designed and executed customer strategy, supported by a CRM system, provides the financial payoff. Acquiring the Right Customers Customer relationship management directs attention to two critical assets of the business-to-business firm: its stock of current and potential customer relationships and its collective knowledge of how to select, initiate, develop, and maintain profitable 29 George S. Day, “Capabilities for Forging Customer Relationships,” Working Paper, Report No. 00-118, Marketing Science Institute, Cambridge, MA, 2000, p. 4. 30 Larry Yu, “Successful Customer-Relationship Management,” MIT Sloan Management Review 42 (Summer 2001): p. 18. 31 Darrell K. Rigby, Frederick F. Reichheld, and Phil Schefter, “Avoid the Four Perils of CRM,” Harvard Business Review 80 ( January–February 2002): p. 102. Chapter 4 Customer Relationship Management Strategies for Business Markets 105 CREATING A CUSTOMER RELATIONSHIP MANAGEMENT STRATEGY TABLE 4.3 CRM Priorities Acquiring the Right Customers Crafting the Right Value Proposition Instituting the Best Processes Motivating Employees Learning to Retain Customers • Identify the tools your employees need to foster customer relationships. • Earn employee loyalty by investing in training and development and constructing appropriate career paths for employees. • Understand why customers defect and how to win them back. • Identify the strategies your competitors are using to win your high-value customers. Critical Tasks • Determine the products or services your customers need today and will need tomorrow. • Assess the products or services that your competitors offer today and tomorrow. • Identify new products or services that you should be offering. • Identify your most valuable customers. • Calculate your share of their purchases (wallet) for your goods and services. • Research the best way to deliver your products or services to customers. • Determine the service capabilities that must be developed and the technology investments that are required to implement customer strategy. CRM Technology Can Help • Analyze customer revenue and cost data to identify current and future high-value customers. • Target marketing communications to high-value customers. • Capture relevant product and service behavior data from customer transactions. • Create new distribution channels. • Develop new pricing models. • Process transactions faster. • Provide better information to customer contact employees. • Manage logistics and the supply chain more efficiently. • Align employee incentives and performance measures. • Distribute customer knowledge to employees throughout the organization. • Track customer defection and retention levels. • Track customer service satisfaction levels. SOURCE: Adapted from Darrell K. Rigby, Frederick F. Reichheld, and Phil Schefter, “Avoid the Four Perils of CRM,” Harvard Business Review 80 ( January–February 2002): p. 106. relationships with these customers.32 Customer portfolio management, then, is the process of creating value across a firm’s customer relationships—from transactional to collaborative—with an emphasis on balancing the customer’s desired level of relationship against the profitability of doing so.33 32 Ruth N. Bolton, Katherine N. Lemon, and Peter Verhoof, “Expanding Business-to-Business Customer Relationships,” Journal of Marketing 72 (January 2008): pp. 46–64. 33 Michael D. Johnson and Fred Selnes, “Diversifying Your Customer Portfolio,” MIT Sloan Management Review 46 (Spring 2005): pp. 11–14. 106 Part II Managing Relationships in Business Marketing INSIDE BUSINESS MARKETING Diversify a Customer Portfolio Too! For an investor, modern portfolio theory demonstrates that optimal performance, for a given level of risk, can best be achieved by building a diversified mix of investment assets that includes the stocks of both large and small firms, representing both U.S. and foreign companies. In building a customer portfolio, similar benefits can be realized by viewing customers as assets and diversifying across categories of customers. For example, after the technology bubble, many information technology (IT) companies, like IBM and Microsoft, were surprised to observe that small and medium-sized businesses (SMB) fueled the recovery in IT spending. Why? Most of the SMB customers did not overindulge in massive hardware and software upgrades to the same extreme extent during the bubble as their largeenterprise counterparts did. So, SMB customers were the first to return and aggressively buy IT products and services. Because Dell, Microsoft, and IBM each have a customer portfolio that includes a strong representation of SMB customers, these firms enjoyed an edge over rivals such as Hewlett-Packard and Sun Microsystems that were less focused on this customer group (that is, asset category) and were “caught waiting” for large-enterprise customers to return. SOURCE: Mark Veverka, “Little Guys Lead IT Spending Recovery,” Barron’s, October 20, 2003, p. 73. Account selection requires a clear understanding of customer needs, a tight grasp on the costs of serving different groups of customers, and an accurate forecast of potential profit opportunities. The choice of potential accounts to target is facilitated by an understanding of how different customers define value. Value, as defined by James Anderson and James Narus, refers to “the economic, technical, service, and social benefits received by a customer firm in exchange for the price paid for a product offering.”34 By gauging the value of their offerings to different groups of customers, business marketers are better equipped to target accounts and to determine how to provide enhanced value to particular customers. The account selection process should also consider profit potential. Because the product is critical to their operations, some customers place a high value on supporting services (for example, technical advice and training) and are willing to pay a premium price for them. Other customers are most costly to serve, do not value service support, and are extremely price sensitive. Because customers have different needs and represent different levels of current and potential opportunities, a marketer should divide its customers into groups. The marketer wishes to develop a broader and deeper relationship with the most profitable ones and assign a low priority to the least profitable ones.35 Frank Cespedes asserts that account selection, therefore, must be explicit about which demands the seller can meet and leverage in dealings with other customers. Otherwise, the seller 34 Anderson and Narus, p. 98. See also Ajay Menon, Christian Homburg, and Nikolas Beutin, “Understanding Customer Value in Business-to-Business Relationships,” Journal of Business-to-Business Marketing 12 (2, 2005): pp. 1–33; and Ulaga and Eggert, “Value-Based Differentiation,” pp. 119–136. 35 Frederick F. Reichheld, “Lead for Loyalty,” Harvard Business Review 79 (July–August 2001): pp. 76–84. Chapter 4 Customer Relationship Management Strategies for Business Markets 107 risks overserving unprofitable accounts and wasting resources that might be allocated to other customer groups.36 Crafting the Right Value Proposition A value proposition represents the products, services, ideas, and solutions that a business marketer offers to advance the performance goals of the customer organization. Recall from Chapter 1 that the customer value proposition must address this essential question: How do the value elements (benefits) in a supplier’s offering compare to those of the nextbest alternative? A value proposition may include points of parity (certain value elements are the same as the next-best option) and points of difference (the value elements that make the supplier’s offering either superior or inferior to the next-best alternative). For example, a supplier may offer improved technology (positive) at a higher price (negative) and fail to convince customers that the new technology justifies the price increase. Best-practice suppliers base their value proposition on the few elements that matter most to target customers, demonstrate the value of this superior performance, and communicate it in a way that conveys a sophisticated understanding of the customer’s business priorities.37 The Bandwidth of Strategies To develop customer-specific product offerings, the business marketer should next examine the nature of buyer-seller relationships in the industry. The strategies competing firms in an industry pursue fall into a range referred to as the industry bandwidth of working relationships.38 Business marketers either attempt to span the bandwidth with a portfolio of relationship-marketing strategies or concentrate on a single strategy, thereby having a narrower range of relationships than the industry bandwidth. Observe in Figure 4.5 how two different industries (medical equipment and hospital supplies) are positioned on the relationship continuum. Because the underlying technology is complex and dynamic, collaborative relations characterize the medical equipment industry. Here, a range of services—technical support, installation, professional training, and maintenance agreements—can augment the core product. By contrast, collaborative relations in the hospital supply industry tend to be more focused and center on helping health-care organizations meet their operational needs (for example, efficient ordering processes and timely delivery). By diagnosing the spectrum of relationship strategies competitors in an industry follow, a business marketer can tailor strategies that more closely respond both to customers who desire a collaborative emphasis and to those who seek a transaction emphasis. The strategy involves flaring out from the industry bandwidth in the collaborative as well as in the transactional direction (see Figure 4.5b). Flaring Out by Unbundling An unbundling strategy can reach customers who desire a greater transaction emphasis. Here, related services are unbundled to yield the 36 Frank V. Cespedes, Concurrent Marketing: Integrating Product, Sales, and Service (Boston: Harvard Business School Press, 1995), p. 193. See also Don Peppers, Martha Rogers, and Bob Dorf, “Is Your Company Ready for One-to-One Marketing?” Harvard Business Review 77 (January–February 1999): pp. 151–160. 37 James C. Anderson, James A. Narus, and Wouter van Rossum, “Customer Value Propositions in Business Markets,” Harvard Business Review 84 (March 2006): p. 93. 38 This discussion draws on Anderson and Narus, “Partnering as a Focused Market Strategy,” pp. 95–113. 108 Part II Managing Relationships in Business Marketing FIGURE 4.5 TRANSACTIONAL AND COLLABORATIVE WORKING RELATIONSHIPS (a) Industry Relationship Bandwidths Pure Transactional Exchange Hospital Supplies (e.g. surgical gloves, syringes) Medical Equipment (e.g. imaging systems) Pure Collaborative Exchange (b) "Flaring Out" from the Industry Bandwidth Pure Transactional Exchange Pure Collaborative Exchange Hospital Supplies a b c d SOURCE: Adapted from James C. Anderson and James A. Narus, “Partnering as a Focused Marketing Strategy,” California Management Review 33 (Spring 1991): p. 97. core product (a in Figure 4.5b), which meets a customer’s basic price, quality, and availability requirements. For each service that is unbundled, the price is lowered. Augmented services, such as technical assistance, consulting, and just-in-time delivery, are each offered, but in a menu fashion, on an incremental price basis. Importantly, the price increments for the entire set of unbundled services should be greater than the price premium sought for the collaborative offering. This reflects the efficiencies of providing the complete bundle of services to a collaborative account. This pricing policy is market oriented in that it allows customer firms to choose the product and relationship offering that they perceive to provide the greatest value. Flaring Out with Augmentation At the other extreme, the collaborative offering (d in Figure 4.5b) becomes the augmented product enriched with features the customer values. Augmented features might include coordinated cost-reduction programs, technical assistance, delivery schedule guarantees, and cooperative advertising. Because collaborative efforts are designed to add value or reduce the costs of exchange between partnering firms, a price premium should be received for the collaborative offering. Allegiance Healthcare Corporation has developed ways to improve hospital supply ordering, delivery, and billing that provide enhanced value to the customer.39 39 Valarie A. Zeithaml, Roland T. Rust, and Katherine N. Lemon, “The Customer Pyramid: Creating and Serving Profitable Customers,” California Management Review 43 (Summer 2001): p. 134. Chapter 4 Customer Relationship Management Strategies for Business Markets 109 Instead of miscellaneous supplies arriving in boxes sorted at the convenience of Allegiance’s needs, they arrive on “client-friendly” pallets customized to meet the distribution needs of the individual hospital. Moreover, hospitals can secure a structural connection to Allegiance through its ValueLink ordering system for added value and convenience. Creating Flexible Service Offerings Business marketers can gain a competitive edge by creating a portfolio of service offerings and then drawing on this portfolio to provide customized solutions for groups of customers or even individual customers.40 First, an offering should be created that includes the bare-bones-minimum number of services valued by all customers in a particular market segment. Microsoft refers to these offerings as “naked solutions.” Second, optional services are created that add value by reducing costs or improving the performance of a customer’s operations. To meet the needs of particular customers, optional services can then be “custom wrapped” with the core offering to create added value. Instituting the Best Processes The sales force assumes a central relationship-management role in the business market. Technical service and customer service personnel also assume implementation roles that are important and visible in buying organizations. Successful relationship strategies are shaped by an effective organization and deployment of the personal selling effort and close coordination with supporting units, such as logistics and technical service. Some firms divide the sales organization into units that each serve a distinct relationship category such as transactional accounts or partnership accounts. Through a careful screening process, promising transaction accounts are periodically upgraded to partnerships. Best Practices at IBM41 In serving a particular customer, a number of IBM employees come into contact with the customer organization. To ensure consistent strategy execution, IBM identifies three customer-contact roles for each of its accounts, specifies desired measurable actions for each role, and monitors the customer’s degree of satisfaction with each role (Table 4.4). The IBM client representative assigned to the customer is the relationship owner, but the account team may include other specialists who complete a project for the customer (project owner) or solve a particular customer problem ( problem resolution owner). Any IBM employee who works on the account can secure timely information from the CRM system to identify recent actions or issues to be addressed. Moreover, for each role, there is an in-process measure and a customer feedback measure. Consider an IBM technical manager assigned responsibility for installing CRM software for a large bank. As a project owner, this manager’s goal is to determine 40 James C. Anderson and James A. Narus, “Capturing the Value of Supplementary Services,” Harvard Business Review 73 ( January–February 1995): pp. 75–83. See also David Rickard, “The Joys of Bundling: Assessing the Benefits and Risks,” The Boston Consulting Group, Inc., 2008, accessed at http://www.bcg.com on May 15, 2008. 41 This discussion is based on Larry Schiff, “How Customer Satisfaction Improvement Works to Fuel Full Business Recovery at IBM,” Journal of Organizational Excellence 20 (Spring 2001): pp. 3–18. 110 Part II Managing Relationships in Business Marketing TABLE 4.4 ROLE-BASED STRATEGY EXECUTION AT IBM: MEASURED ACTIONS AND RESULTS Role Strategy Goal Measured Actions Relationship Owner Improve Customer Relationships Project Owner Exceed Customer Expectations for Each Transaction Fix Customer Problems Meet with customer twice per year to identify customer’s expectations and set action plan Collect conditions of satisfaction, get customer feedback Solve in seven days or meet action plan Problem Resolution Measured Results (Customer) IBM Customer Satisfaction Survey Results IBM Transaction Survey Results Customer Satisfaction with Problem Resolution SOURCE: Adapted from Larry Schiff, “How Customer Satisfaction Improvement Works to Fuel Business Recovery at IBM,” Journal of Organizational Excellence (Spring 2001): pp. 12–14. the customer’s conditions of satisfaction and then exceed those expectations. When the work is completed, members of the customer organization are queried concerning their satisfaction and the project owner acts on the feedback to ensure that all promises have been kept. Clearly, a sound complaint management process is essential. Recent research found that if a complaint is ineffectively handled, the firm faces a high risk of losing even those customers who had previously been very satisfied.42 Research suggests that the performance attributes that influence the customer satisfaction of business buyers include: • the responsiveness of the supplier in meeting the firm’s needs, • product quality, • a broad product line, • delivery reliability, • knowledgeable sales and service personnel.43 Motivating Employees Dedicated employees are the cornerstone of a successful customer relationship strategy. Frederick F. Reichheld notes: Leaders who are dedicated to treating people right drive themselves to deliver superior value, which allows them to attract and retain the best employees. That’s partly because higher profits result from customer retention, but more important, it’s because providing excellent service and value generates pride and a sense of purpose among employees.44 42 Christian Homburg and Andreas Fürst, “How Organizational Complaint Handling Drives Customer Loyalty: An Analysis of the Mechanistic and the Organic Approach,” Journal of Marketing 69 (July 2005): pp. 95–114. 43 Bowman and Narayandas, “Linking Customer Management Effort,” pp. 433–447. 44 Reichheld, “Lead for Loyalty,” p. 78. Chapter 4 Customer Relationship Management Strategies for Business Markets 111 Employee loyalty is earned by investing heavily in training and development, providing challenging career paths to facilitate professional development, and aligning employee incentives to performance measures.45 For example, Square D, an Illinoisbased producer of electrical and industrial equipment, altered its performancemeasurement and incentive systems to fit the firm’s new customer strategy. Consistent with the goal of attracting high-value customers, salesperson incentives are no longer based on the number of units sold but on the number of customers acquired and on profit margins. Research clearly demonstrates the link between salespeople’s job satisfaction and customer satisfaction in business markets. Christian Homburg and Ruth M. Stock report that the relationship between salespeople’s job satisfaction is particularly strong when there is a high frequency of customer interaction, high intensity of customer integration into the value-creating process, and high product or service innovativeness.46 Learning to Retain Customers Business marketers track customer loyalty and retention because the cost of serving a long-standing customer is often far less than the cost of acquiring a new customer.47 Why? Established customers often buy more products and services from a trusted supplier and, as they do, the cost of serving them declines. The firm learns how to serve them more efficiently and also spots opportunities for expanding the relationship. Thus, the profit from that customer tends to increase over the life of the relationship. To that end, a goal for IBM is to gain an increasing share of a customer’s total information technology expenditures (that is, share of wallet). Rather than merely attempting to improve satisfaction ratings, IBM seeks to be recognized as providing superior value to its customers. Larry Schiff, an IBM strategist, notes: “If you delight your customers and are perceived to provide the best value in your market, you’ll gain loyalty and market /wallet share.”48 Although loyal customers are likely to be satisfied, all satisfied customers do not remain loyal. Business marketers earn customer loyalty by providing superior value that ensures high satisfaction and by nurturing trust and mutual commitments. Pursuing Growth from Existing Customers Business marketers should identify a well-defined set of existing customers who demonstrate growth potential and selectively pursue a greater share of their business. Based on the cost-to-serve and projected profit margins, the question becomes: Which of our existing customers represent the best growth prospects? In targeting individual customers, particular attention should be given to: (1) estimating the current share of wallet the firm has attained; (2) pursuing opportunities to increase that share; and (3) carefully projecting the enhanced customer profitability that will result.49 45 Rigby, Reichheld, and Schefter, “Avoid the Perils of CRM,” p. 104. 46 Christian Homburg and Ruth M. Stock, “The Link Between Salespeople’s Job Satisfaction and Customer Satisfaction in a Business-to-Business Context: A Dyadic Analysis,” Journal of the Academy of Marketing Science 32 (Spring 2004): pp. 144–158; and Christian Homburg and Ruth M. Stock, “Exploring the Conditions Under Which Salesperson Work Satisfaction Can Lead to Customer Satisfaction,” Psychology & Marketing 22 (5, 2005): pp. 393–420. 47 Reichheld, “Lead for Loyalty,” pp. 76–84. 48 Schiff, “How Customer Satisfaction Improvement Works to Fuel Full Business Recovery at IBM,” p. 8. 49 James C. Anderson and James A. Narus, “Selectively Pursuing More of Your Customer’s Business,” MIT Sloan Management Review 44 (Spring 2003): pp. 42–49. 112 Part II Managing Relationships in Business Marketing Evaluating Relationships Some relationship-building efforts fail because the expectations of the parties do not mesh—for example, when the business marketer follows a relationship approach and the customer responds in a transaction mode. By isolating customer needs and the costs of augmented service features, the marketer is better equipped to profitably match product offerings to the particular customer’s needs. The goal of a relationship is to enable the buyer and seller to maximize joint value. This points to the need for a formal evaluation of relationship outcomes. For example, sales executives at best-practice firms work closely with their partnership accounts to establish mutually defined goals. After an appropriate period, partnerships that do not meet these goals are downgraded and shifted from the strategic market sales force to the geographic sales force. Business marketers should also continually update the value of their product and relationship offering. Attention here should center on particular new services that might be incorporated as well as on existing services that might be unbundled or curtailed. Working relationships with customer firms are among the most important marketing assets of the firm. They deserve delicate care and continual nurturing! Strategic Alliances Not only do business marketing managers form close relationships with customers, they also develop close bonds with other firms. Strategic alliances have become an important tool for achieving a sustainable competitive advantage for leading business firms. To that end, the top 500 global businesses have an average of 60 major strategic alliances each.50 Strategic alliances involve “a formal long-run linkage, funded with direct co-investments by two or more companies, that pool complementary capabilities and resources to achieve generally agreed objectives.”51 In contrast, a joint venture involves the formation of a separate, independent organization by the venture partners. Accessing Complementary Skills The driving force behind the formation of a strategic alliance is the desire of one firm to leverage its core competencies by linking them with others who have complementary expertise, thereby expanding the product, market, and geographic scope of the organization. Simon Hayes, vice president of Enterprise Strategic Alliances at Cisco Systems, observes: By combining the best that partners have to offer, “strategic alliances are helping companies enhance their strategic presence in the marketplace and develop new solutions to attract new customers or even create whole new market categories.”52 Cisco Systems, a recognized leader in partnering and collaboration, has formed deep, long-term relationships with a host of strategic alliance partners, including Microsoft, IBM, Hewlett-Packard, Nokia, Fujitsu, Accenture, Intel, Italtel, 50 Jeffrey H. Dyer, Prashant Kale, and Habir Singh, “How to Make Strategic Alliances Work,” MIT Sloan Management Review 42 (Summer 2001): pp. 37–43. See also Fred A. Kuglin and Jeff Hook, Building, Leading, and Managing Strategic Alliances (New York: AMACOM, 2007). 51 George S. Day, Market Driven Strategy: Processes for Creating Value (New York: The Free Press, 1990), p. 272. 52 Simon Hayes, “Getting Strategic Alliances Right,” Synnovation 3 (May 2008), p. 72, accessed at www.eds.com/synnovation on July 5, 2008. Chapter 4 FIGURE 4.6 Customer Relationship Management Strategies for Business Markets 113 A STRATEGIC ALLIANCE: BEFORE THE HANDSHAKE Will the alliance create value for our customers? Will this alliance generate growth in our core business? Some Tough Questions Before Entering an Alliance What are the strengths and weaknesses of each potential alliance partner? Does this alliance present risks to our business? How compatible are we, both culturally and technically? Are we committed to a long-term relationship? SOURCE: Adapted from Simon Hayes, “Getting Strategic Alliances Right,” Synnovation 3 (May 2008): p. 74, accessed at www.eds.com. and many others. For example, the Microsoft–Cisco alliance, formed more than a decade ago, addresses the needs of enterprise and small and medium-size (SMB) customers who need affordable, integrated customer relationship management (CRM) solutions that advance business results and deliver superior customer service. (See Figure 4.6.) Benefits of Strategic Alliances Partners to an alliance seek benefits such as (1) access to markets or to technology (a motivating force for General Electric’s partnerships in China and India); (2) economies of scale that might be gained by combining manufacturing, R&D, or marketing activities; (3) faster entry of new products to markets (for example, when partners with established channels of distribution in different countries swap new products); and (4) sharing of risk.53 Simply put, there is a tremendous cost—and risk—when a firm creates its own distribution channels, supply chain network, manufacturing plant, and R&D function in every key market in the world. Also, it takes time to develop relationships with channel members and customers and to develop the skills of employees. Alliances provide an inviting option. 53 Kenneth Ohmae, “The Global Logic of Strategic Alliances,” Harvard Business Review 67 (March/April 1989): pp. 143–154. 114 Part II Managing Relationships in Business Marketing Determinants of Alliance Success Although offering significant benefits, alliances often fall short of expectations or dissolve. Managing an alliance involves special challenges. Therefore, the ability to form and manage strategic alliances more effectively than rivals can be an important source of competitive advantage. Building a Dedicated Alliance Function While many firms generate positive results from strategic alliances, an elite group of firms has demonstrated the capability to generate superior alliance value as measured by the extent to which the alliance met its stated objectives, the degree to which the alliance enhanced the company’s competitive position, stock market gains from alliance announcements, and related performance dimensions. Included among the top performers are firms such as Hewlett-Packard, Oracle, Eli Lily & Company, and others. How did they do it? By creating a dedicated strategic alliance function—headed by a vice president or director of strategic alliances with his or her own staff and budget, says Jeffrey H. Dyer and his research team.54 “The dedicated function coordinates all alliance-related activity within the organization and is charged with institutionalizing processes and systems to teach, share, and leverage prior alliance management experience and know-how throughout the company.”55 Simon Hayes, the Cisco vice president who heads the dedicated alliance function, says: At Cisco, we’re investing in our alliances with best-practice “videos on demand,” strategic alliance leadership-development programs, and strategic scenario-analysis workshops. We believe that the best way to show commitment is with a dedicated, trained, and capable alliance team.56 Developing a Joint Value Proposition Even before negotiations begin, the partners should develop a strategy map that details the shared strategy and the specific value proposition that the partners will deliver to the customer. A close and concise statement of the value proposition is an essential step to getting the organization aligned around a common view of the alliance strategy goals, agreeing upon the unique benefits that the partners will jointly offer to customers. Developing Close Working Relationships Rosabeth Moss Kanter emphasizes: “Alliances . . . require a dense web of interpersonal connections and internal infrastructures that enhance learning.”57 Observe the interpersonal connections that unite two Fortune 500 firms (referred to as Alpha Communications and Omega Financial Services) in an alliance that markets a cobranded credit and calling card targeted to the business market (see Figure 4.7). The lines connect alliance personnel who have frequent and important communications and who consider the working relationship to be close. These managers are the core participants in the work of the alliance, in contrast to others who are more loosely connected to the alliance team in each 54 Dyer, Kale, and Singh, “How to Make Alliances Work,” p. 37. 55 Ibid., p. 38. 56 Hayes, “Getting Strategic Alliances Right,” p. 76. 57 Kanter, “Collaborative Advantage,” p. 97. Chapter 4 Customer Relationship Management Strategies for Business Markets 115 SOCIAL CONNECTIONS IN AN ALLIANCE FIGURE 4.7 Omega Alpha 22 17 2 3 5 34 20 38 35 14 26 25 36 7 16 8 12 9 31 11 27 19 24 4 13 39 21 15 41 33 Boundary Spanners 1 Peripheral Participants Core Participants 40 37 29 42 23 6 10 28 18 30 32 Peripheral Participants Strong Linkages Across Firms Strong Linkages Within Firms Most Senior Executive Project Manager SOURCE: Reprinted from Michael D. Hutt, Edwin R. Stafford, Beth A. Walker, and Peter H. Reingen, “Defining the Social Network of a Strategic Alliance: A Case Study,” MIT Sloan Management Review 41 (Winter 2000): p. 56, by permission of the publisher. Copyright © 2000 by Massachusetts Institute of Technology. All rights reserved. organization (peripheral participants). The interpersonal links among the core participants are the circuits through which alliance information flows, decisions are made, and conflicts are resolved. Boundary-Spanning Connections Fundamental to the success of the alliance are the working relationships (those connected by the dark lines in Figure 4.7) that span organizational boundaries and unite the partnering firms. These boundary-spanning managers (for example, #12 in Alpha and #39 in Omega) have strong communication and friendship links with other managers both within their respective organizations and within the partnering firm. Frequent interactions, the timely exchange of information, and accurate feedback on each partner’s actions will minimize misperceptions and strengthen cooperation in an alliance. Likewise, communication among boundary-spanning personnel produces a shared interpretation of goals and common agreement on norms, work roles, and the nature of social relationships. As close working relationships develop among the alliance participants, psychological contracts, based on trust and shared goals, replace the formal alliance agreement. Psychological contracts consist of unwritten and largely nonverbalized sets of congruent expectations and assumptions held by the parties to the alliance about 116 Part II Managing Relationships in Business Marketing each other’s prerogatives and obligations.58 By promoting openness and flexibility, these interpersonal bonds can speed alliance progress—decisions can be made quickly, unexpected events can be more readily handled, learning is enhanced, and new possibilities for joint action emerge. Integrating Points of Contact Firms that are adept at managing strategic alliances use a flexible approach, letting their alliances evolve in form as conditions change over time. They invest adequate resources and management attention in these relationships, and they integrate the organizations so that the appropriate points of contact and communication are managed. Successful alliances achieve five levels of integration:59 1. Strategic integration, which entails continuing contact among senior executives to define broad goals or discuss changes in each company; 2. Tactical integration, which brings middle managers together to plan joint activities, to transfer knowledge, or to isolate organizational or system changes that will improve interfirm connections; 3. Operational integration, which provides the information, resources, or personnel that managers require to carry out the day-to-day work of the alliance; 4. Interpersonal integration, which builds a necessary foundation for personnel in both organizations to know one another personally, learn together, and create new value; and 5. Cultural integration, which requires managers involved in the alliance to have the communication skills and cultural awareness to bridge the differences. The Social Ingredients of Alliance Success60 In a strategic alliance, interpersonal relationships matter. The goals of an alliance cannot be realized in practice until many managers in both organizations know one another personally and take coordinated action to create new value together. Indeed, many alliances that appear to make strategic sense fail to meet expectations because little attention is given to cultivating the interpersonal connections and communication patterns that underlie effective collaboration. Strong interpersonal ties must be forged to unite managers in the partnering organizations and continuing boundaryspanning activity is required at multiple managerial levels as a relationship evolves. Laying the Foundation Alliance negotiations set the tone for the relationship. Smooth alliance negotiations rest on finding the proper balance between the formal, legal procedures that establish detailed contractual safeguards for the parties and the informal, interpersonal processes that are crucial in the successful execution of alliance strategy. 58 Peter Smith Ring and Andrew H. Van de Ven, “Developmental Processes of Cooperative Interorganizational Processes,” Academy of Management Review 19 (January 1992): pp. 90–118. 59 Kanter, “Collaborative Advantage,” pp. 105–107. 60 This section is based on Michael D. Hutt, Edwin R. Stafford, Beth A. Walker, and Peter H. Reingen, “Defining the Social Network of a Strategic Alliance: A Case Study,” MIT Sloan Management Review 41 (Winter 2000): pp. 51–62. Chapter 4 Customer Relationship Management Strategies for Business Markets 117 Legal documents that establish an alliance and specify the boundaries in elaborate detail are still not complete and exhaustive. Countless ambiguities become evident as middle managers begin to flesh out the specific elements of the alliance plan. To resolve these issues and move the alliance forward, it is here that personal relationships begin to develop and supplement formal role relationships. Alliance negotiations should be structured in a manner that promotes the development of these interpersonal ties. Experts suggest that more effective transactions are likely to evolve when managers, rather than lawyers, develop and control the negotiation strategy.61 In turn, “negotiations appear to go more smoothly when parties from different organizations interact with their role counterparts (for example, managers to managers or lawyers to lawyers).”62 Interactions between lawyers are largely based on institutionalized professional norms, center on a specific activity, and take place over a relatively short period of time. A signed agreement culminates the work of the lawyers; manager-to-manager relationships formed during negotiations provide the social structure through which the goals of the alliance can be realized. Isolating Top-Management’s Role Beyond establishing joint goals and determining how the alliance fits each firm’s total strategy, senior executives define the meaning of the relationship and signal its importance to personnel in the respective firms. Topmanagement’s involvement in a strategic alliance encompasses much more than merely appointing an alliance manager or project leader. In addition to creating a dedicated strategic alliance function, many business-to-business firms, like General Electric and Cisco, appoint an executive sponsor for each alliance. For an alliance-based strategy to succeed, an ongoing level of backing from top management is required. Executive leadership also assumes a critical role in communicating the strategic role of the alliance and in creating an identity for the alliance within the organization. A senior executive’s personal involvement galvanizes support for an alliance throughout the organization. Moreover, direct ties at the top-management level across partnering firms spawn organizational commitment and more active involvement between managers at multiple levels of the hierarchy. If visible participation by senior executives is lacking, the members of the alliance team will begin to question the importance of the initiative to their firm and the value of team membership to their careers. Cultivating a Network of Relationships To achieve alliance goals, a well-integrated communication and work-flow network among managers is required within and across firms. A regular audit of evolving social, work, and communication ties can be a valuable tool for management in gauging the health of an alliance and in spotting problem areas. In reviewing the alliance network, attention first should center on relationship patterns at multiple levels. In particular, connections should be examined among operating personnel who require timely access to information and resources; between the project leaders who establish the climate for the alliance, craft the strategy, and manage execution; and among senior managers who signal the importance of the relationship in their respective organizations, lend critical support at key points, and are central to discussions of new opportunities for successful collaboration. 61 Peter Smith Ring and G. Rands, “Sensemaking, Understanding, and Committing: Emergent Transaction Processes in the Evolution of 3M’s Microgravity Research Programs,” in A.H. Van de Ven, H. Angle, and M. S. Poole, eds., Research on the Management of Innovation: The Minnesota Studies (New York: Ballinger/Harper & Row, 1989), pp. 337–366. 62 Peter Smith Ring and Andrew H. Van de Ven, “Developmental Processes of Cooperative Interorganizational Processes,” Academy of Management Review 19 (January 1992): p. 109. 118 Part II Managing Relationships in Business Marketing Summary Relationships, rather than simple transactions, provide the central focus in business marketing. By demonstrating superior skills in managing relationships with key customers as well as with alliance partners, business marketing firms can create a collaborative advantage. To develop profitable relationships with customers, business marketers must first understand the different forms that exchange relationships can take. Transactional exchange centers on the timely exchange of basic products and services for highly competitive market prices. By contrast, collaborative exchange involves very close personal, informational, and operational connections the parties develop to achieve longterm mutual goals. Across the relationship spectrum, different types of relationships feature different relationship connectors. For example, collaborative relationships for important purchases emphasize operational linkages that integrate the operations of the buying and selling organizations and involve high levels of information exchange. Activity-based costing provides a solid foundation for measuring and managing the profitability of individual customers. When the full costs of serving customers are known, many companies find that 15 to 20 percent of the customers generate 100 percent (or much more) of the profits, a large group of customers break even, and 5 to 10 percent of the customers generate sizable losses. By measuring the cost-toserve and the net profit from individual customers, business marketing managers can take actions to transform unprofitable relationships into profitable ones through process improvements, menu-based pricing, or relationship management. Customer relationship management involves aligning customer strategy and business processes for the purpose of improving customer loyalty and, eventually, corporate profitability. To that end, a customer strategy encompasses (1) acquiring the right customers, (2) crafting the right value proposition, (3) instituting the best processes, (4) motivating employees, and (5) learning to retain customers. The driving force behind the formation of a strategic alliance is the desire of one firm to leverage its core competencies by linking with another firm that has complementary expertise, thereby creating joint value and new market opportunities. Firms adept at managing strategic alliances create a dedicated alliance function, develop a shared strategy map and a clear value proposition that the partners will provide to target customers, and nurture the interpersonal relationships that are crucial to success. A well-integrated communication and work-flow network is required within and across firms. And senior executives’ personal involvement galvanizes crucial support. A regular audit of evolving relationship ties can be a valuable tool for gauging an alliance’s health. Discussion Questions 1. A marketing research company found that 6 percent of its clients generated 30 percent of sales and nearly all of its profits. At the other end of the continuum, 70 percent of its clients provided annual billings (revenue) that were below break-even levels, because these customers required an extensive amount of service from research employees. The company took immediate action to terminate relationships with clients who would not give them a higher share of their marketing research expenditures. Evaluate this decision and suggest a set of criteria that the firm might use to screen new clients. Chapter 4 Customer Relationship Management Strategies for Business Markets 119 2. Describe how a firm might use menu-based pricing to restore profitability to a high-cost-to-serve customer who demands extensive service and customized support. 3. Evaluate this statement: Large customers tend to be either the most or least profitable in the customer base of a business-to-business firm. 4. Sony develops “collaborative relationships” with some suppliers and “transactional relationships” with other suppliers. What criteria would purchasing executives use in segmenting suppliers into these two categories? Describe the steps a business marketer might take to move the relationship with Sony from a transaction relationship to a more collaborative one. 5. Some consulting organizations persuasively argue that by properly incorporating suppliers into their product-development process, firms can cut their bills for purchased parts and materials by as much as 30 percent. Explore how a buyer-seller partnership might create these cost savings. 6. Concerning buyer-seller relationships, compare and contrast the features of a collaborative relationship versus a transactional relationship in the business market. Describe how the operational linkages might differ by relationship type. 7. Why is the cost of serving a long-standing customer far less than the cost of acquiring a new customer? 8. Discuss the switching costs that Southwest Airlines would incur if it began to phase out its fleet of Boeing airliners with replacements from Airbus. What steps could Airbus take to reduce these switching costs? How might Boeing counter to strengthen its relationship with Southwest? 9. Describe how an office supply firm may have a core offering of products and services for a small manufacturer and an augmented offering for a university. 10. Knowing how to be a good partner is an asset in the business market as Cisco Systems clearly demonstrates. Describe the characteristics of a successful strategic alliance and outline the steps that alliance partners can take to increase the odds that alliance goals will be achieved. Internet Exercises 1. Oracle Corporation provides customer relationship management software solutions to all sectors of the business market. Go to http:// oracle.com and review “success stories” and a. identify a particular Oracle customer from the government sector, and b. describe the benefits that this government customer received from the software solution. CASE Hewlett-Packard Challenges from a Diverse Mix of Demanding Customers Hewlett Packard (H-P) serves a diverse set of customers in the business market and devotes special attention to the Global 1,000—the 1,000 largest enterprises in the world. Across these organizations, however, different perspectives and approaches are used in making information technology (IT) purchases. This diversity across customer groups presents a host of challenges for H-P. • Customer Group A demands a wide variety of IT products, routine maintenance support, and customized services. These customers value the relationship with H-P and are willing to pay a premium for product and service quality. • Customer Group B wants high-quality IT products (e.g., printers, servers) but, most of all, these customers want a rock-bottom price and choose suppliers on that basis. • Customer Group C demands both quality products and extensive service support but wants all of this for a “rock-bottom” price. These customers will freely switch from one supplier to the next. As competition intensifies for H-P and others in the IT sector, more customers are moving into this group each month. First, describe how H-P might develop a portfolio of relationship strategies to meet the needs of such diverse customer groups. Second, some customers in each group are more costly to serve than others. How should such cost differences be reflected in the particular relationship strategies that H-P follows? Third, what strategies can H-P follow to increase the switching costs of customers in Group B or Group C or increase the profits it derives from these customer groups? 120 PART III ASSESSING MARKET OPPORTUNITIES 121 This page intentionally left blank CHAPTER 5 Segmenting the Business Market and Estimating Segment Demand The business marketing manager serves a market comprising many different types of organizational customers with varying needs. Only when this aggregate market is broken down into meaningful categories can the business marketing strategist readily and profitably respond to unique needs. Once the segments are determined, then the marketer must estimate demand for each segment. Accurate projections of future sales are one of the most significant and challenging dimensions of organizational demand analysis. After reading this chapter, you will understand: 1. the benefits of and requirements for segmenting the business market. 2. the potential bases for segmenting the business market. 3. a procedure for evaluating and selecting market segments. 4. the role of market segmentation in the development of business marketing strategy. 5. a process for estimating demand in each market segment. 6. specific techniques to effectively develop a forecast of demand. 123 124 Part III Assessing Market Opportunities A strategist at Hewlett-Packard notes: Knowing customers’ needs is not enough. . . . We need to know what new products, features, and services will surprise and delight them. We need to understand their world so well that we can bring new technology to problems that customers may not yet truly realize they have.1 High-growth companies, large and small, succeed by • selecting a well-defined group of potentially profitable customers. • developing a distinctive value proposition (product and/or service offering) that meets these customers’ needs better than their competitors. • focusing marketing resources on acquiring, developing, and retaining profitable customers.2 The business market consists of three broad sectors—commercial enterprises, institutions, and government. Whether marketers elect to operate in one or all of these sectors, they encounter diverse organizations, purchasing structures, and decisionmaking styles. Each sector has many segments; each segment may have unique needs and require a unique marketing strategy. For example, some customers demonstrate attractive profit potential and are receptive to a relationship strategy, whereas others adopt a short-term, transaction focus, suggesting the need for a more streamlined strategy response.3 The business marketer who recognizes the needs of the various market segments is best equipped to isolate profitable market opportunities and respond with an effective marketing program. Once market segments are defined, it is then necessary to forecast the expected demand in each segment. In fact, forecasting of demand is an on-going process because forecasts drive so many of the management activities of the business-to-business marketer. Demand forecasts provide the basis on which organizations decide on how to allocate resources, plan manufacturing capacity and output, develop logistics capabilities and strategies, and establish marketing budgets and activities. The goal of this chapter is to demonstrate how the manager can select and evaluate segments of the business market and then develop accurate estimates of demand. First, the chapter delineates the benefits of and the requirements for successful market segmentation. Second, it explores and evaluates specific bases for segmenting the business market. Third, the chapter provides a framework for evaluating and selecting market segments. Procedures for assessing the costs and benefits of entering alternative market segments and for implementing a segmentation strategy are emphasized. The final section of the chapter examines the demand forecasting process and explains the critical aspects of how business marketers create demand forecasts. 1 David E. Schnedler, “Use Strategic Market Models to Predict Customer Behavior,” Sloan Management Review 37 (Spring 1996): p. 92; see also, Eric von Hippel, Stefan Thomke, and Mary Sonnack, “Creating Breakthroughs at 3M,” Harvard Business Review 77 (September–October 1999): pp. 47–57. 2 Dwight L. Gertz and João P. A. Baptista, Grow to Be Great: Breaking the Downsizing Cycle (New York: The Free Press, 1995), p. 54. 3 Per Vagn Freytog and Ann Højbjerg Clarke, “Business to Business Market Segmentation,” Industrial Marketing Manage- ment 30 (August 2001): pp. 473–486. Chapter 5 Segmenting the Business Market and Estimating Segment Demand 125 Business Market Segmentation Requirements and Benefits Yoram Wind and Richard N. Cardozo define a market segment as “a group of present or potential customers with some common characteristic which is relevant in explaining (and predicting) their response to a supplier’s marketing stimuli.”4 Effective segmentation of markets is the first step in crafting a marketing strategy because the characteristics and needs of each segment will define what elements must be included in how the firm approaches each of the segments in which they choose to do business. Segmentation that is done well provides the necessary information for understanding what elements of the marketing mix are going to be critical in satisfying the target customers in those segments. Requirements Potential customers in a market segment have common characteristics that define what things are important to them and how they will respond to various marketing stimuli. The question for the business marketer is: “what are the key criteria for determining which characteristics best define a unique market segment?” A business marketer has four criteria for evaluating the desirability of potential market segments: 1. Measurability—The degree to which information on the particular buyer characteristics exists or can be obtained. 2. Accessibility—The degree to which the firm can effectively focus its marketing efforts on chosen segments. 3. Substantiality—The degree to which the segments are large or profitable enough to be worth considering for separate marketing cultivation. 4. Responsiveness—The degree to which segments respond differently to different marketing mix elements, such as pricing or product features. In summary, the art of market segmentation involves identifying groups of customers that are large and unique enough to justify a separate marketing strategy. The ultimate goal is to have the greatest amount of difference between groups (segments) and high similarities within them.5 Benefits If the requirements for effective segmentation are met, several benefits accrue to the firm. First, the mere attempt to segment the business market forces the marketer to become more attuned to the unique needs of customer segments. Second, knowing 4 Yoram Wind and Richard N. Cardozo, “Industrial Market Segmentation,” Industrial Marketing Management 3 (March 1974): p. 155; see also Vincent-Wayne Mitchell and Dominic F. Wilson, “Balancing Theory and Practice: A Reappraisal of Business-to-Business Segmentation,” Industrial Marketing Management 27 (September 1998): pp. 429–455. 5 Jessica Tsai, “The Smallest Slice,” CRM Magazine 12 (2, Feb. 2008): p. 37. 126 Part III Assessing Market Opportunities INSIDE BUSINESS MARKETING How to See What’s Next Strategists falter when they invest too much attention to “what is” and too little to “what could be.” For example, by maintaining a strict focus on existing market segments and ignoring new ones, the business marketer may miss important signals of change that customers are sending. To break this pattern and spot new market opportunities, business marketing strategists should examine three customer groups and the market signals they are sending: • Undershot customers—the existing solutions fail to fully satisfy their needs. They eagerly buy new product versions at steady or increasing prices. • Overshot customers—the existing solutions are too good (for example, exceed the technical performance required). These customers are reluctant to purchase new product versions. • Nonconsuming customers—those who lack the skills, resources, or ability to benefit from existing solutions. These customers are forced to turn to others with greater skills or training for service. Although most strategists center exclusive attention on undershot customers, “watching for innovations that have the potential to drive industry change actually requires paying careful attention to the least demanding, most overshot customers and non-consumers seemingly on the fringe of the market.” For example, computing jobs that were processed by specialists in the corporate mainframe computer center are now routinely completed by millions of individuals, and corporate photocopying centers were disbanded as low-cost, self-service copiers became a common fixture in offices across organizations. SOURCE: Clayton M. Christensen and Scott D. Anthony, “Are You Reading the Right Signals?” Strategy & Innovation Newsletter (Cambridge, MA.: Harvard Business School Publishing Corporation, September/October 2004), p. 5. the needs of particular market segments helps the business marketer focus productdevelopment efforts, develop profitable pricing strategies, select appropriate channels of distribution, develop and target advertising messages, and train and deploy the sales force. Thus, market segmentation provides the foundation for efficient and effective business marketing strategies. Third, market segmentation provides the business marketer with valuable guidelines for allocating marketing resources. Business-to-business firms often serve multiple market segments and must continually monitor their relative attractiveness and performance. Research by Mercer Management Consulting indicates that, for many companies, nearly one-third of their market segments generate no profit and that 30 to 50 percent of marketing and customer service costs are wasted on efforts to acquire and retain customers in these segments.6 Ultimately, costs, revenues, and profits must be evaluated segment by segment—and even account by account. As market or competitive conditions change, corresponding adjustments may be required in the firm’s market segmentation strategy. Thus, market segmentation provides a basic unit of analysis for marketing planning and control. 6 Gertz and Baptista, Grow to Be Great, p. 55. Chapter 5 Segmenting the Business Market and Estimating Segment Demand 127 Bases for Segmenting Business Markets Whereas the consumer-goods marketer is interested in securing meaningful profiles of individuals (demographics, lifestyle, benefits sought), the business marketer profiles organizations (size, end use) and organizational buyers (decision style, criteria). Thus, the business or organizational market can be segmented on several bases, broadly classified into two major categories: macrosegmentation and microsegmentation. Macrosegmentation centers on the characteristics of the buying organization and the buying situation and thus divides the market by such organizational characteristics as size, geographic location, the North American Industrial Classification System (NAICS) category, and organizational structure. Such characteristics are important because they often determine the buying needs of the organization. For example, in the plastic packaging industry, a recent study identified seven major packaging and disposable market segments— 1. food packaging; 2. lids, caps, closures, overcaps, and packaging dispensers; 3. preforms; 4. pails; 5. pharmaceutical vials and containers; 6. cosmetics and personal-care items; and, 7. disposable cutlery, bowls, cups, and plates. Collectively, these segments consumed just over 7.3 billion pounds of plastic resins in 2007.7 These macrosegments are significant to the firms that sell materials and components to the plastic packaging industry because each of the major segments has somewhat different needs and requirements for the things that they buy based on the packaging products they are creating. For example, the preform market segment is the fastest-growing segment, which means that competition in this segment will be stiff, requiring a highly responsive marketing approach. In contrast, microsegmentation requires a higher degree of market knowledge, focusing on the characteristics of decision-making units within each macrosegment— including buying decision criteria, perceived importance of the purchase, and attitudes toward vendors. Yoram Wind and Richard Cardozo recommend a two-stage approach to business market segmentation: (1) identify meaningful macrosegments, and then (2) divide the macrosegments into microsegments.8 In evaluating alternative bases for segmentation, the marketer is attempting to identify good predictors of differences in buyer behavior. Once such differences are recognized, the marketer can approach target segments with an appropriate marketing strategy. Secondary sources of information, coupled with data in a firm’s information 7 Bart Thedinger, “Injection Molders See Growth For Packaging & Disposables,” Plastics Technology 54 (5, May 2008): p. 98. 8 Wind and Cardozo, “Industrial Market Segmentation,” p. 155; see also Mitchell and Wilson, “Balancing Theory and Practice,” pp. 429–455. 128 Part III Assessing Market Opportunities TABLE 5.1 SELECTED MACROLEVEL BASES OF SEGMENTATION Variables Illustrative Breakdowns Characteristics of Buying Organizations Size (the scale of operations of the organization) Geographical location Usage rate Structure of procurement Small, medium, large; based on sales or number of employees USA, Asia Pacific, Europe, Middle East, and Africa Nonuser, light user, moderate user, heavy user Centralized, decentralized Product/Service Application NAICS category End market served Value in use Varies by product or service Varies by product or service High, low Characteristics of Purchasing Situation Type of buying situation Stage in purchase decision process New task, modified rebuy, straight rebuy Early stages, late stages system, can be used to divide the market into macrolevel segments. The concentration of the business market allows some marketers to monitor the purchasing patterns of each customer. For example, a firm that sells paper products—tissues, cups, and napkins—to the airlines is dealing with just a handful of potential buying organizations in the U.S. market. There were 12 major airlines operating in the United States in 2007; in comparison, a paper products company selling tissues and the like to ultimate consumers is dealing with literally millions of potential customers. Such market concentration, coupled with rapidly advancing marketing intelligence systems, makes it easier for the business marketer to monitor the purchasing patterns of individual organizations. Macrolevel Bases Table 5.1 presents selected macrolevel bases of segmentation. Recall that these are concerned with general characteristics of the buying organization, the nature of the product application, and the characteristics of the buying situation. Macrolevel Characteristics of Buying Organizations The marketer may find it useful to partition the market by size of potential buying organization. Large buying organizations may possess unique requirements and respond to marketing stimuli that are different from those responded to by smaller firms. The influence of presidents, vice presidents, and owners declines with an increase in corporate size; the influence of other participants, such as purchasing managers, increases.9 Alternatively, the 9 Joseph A. Bellizzi, “Organizational Size and Buying Influences,” Industrial Marketing Management 10 (February 1981): pp. 17–21; see also Arch G. Woodside, Timo Liukko and Risto Vuori, “Organizational Buying of Capital Equipment Involving Persons across Several Authority Levels,” Journal of Business & Industrial Marketing 14 (1, 1999): pp. 30–48. Chapter 5 Segmenting the Business Market and Estimating Segment Demand 129 marketer may recognize regional variations and adopt geographical units as the basis for differentiating marketing strategies. Usage rate constitutes another macrolevel variable. Buyers are classified on a continuum ranging from nonuser to heavy user. Heavy users may have needs different from moderate or light users. For example, heavy users may place more value on technical or delivery support services than their counterparts. Likewise, an opportunity may exist to convert moderate users into heavy users through adjustments in the product or service mix. The structure of the procurement function constitutes a final macrolevel characteristic of buying organizations. Firms with a centralized purchasing function behave differently than do those with decentralized procurement (see Chapter 3). The structure of the purchasing function influences the degree of buyer specialization, the criteria emphasized, and the composition of the buying center. Centralized buyers place significant weight on long-term supply availability and the development of a healthy supplier complex. Decentralized buyers tend to emphasize short-term cost efficiency.10 Thus the position of procurement in the organizational hierarchy provides a base for categorizing organizations and for isolating specific needs and marketing requirements. Many business marketers develop a national accounts sales team to meet the special requirements of large, centralized procurement units. Product/Service Application Because a specific industrial good is often used in different ways, the marketer can divide the market on the basis of specific end-use applications. The NAICS system and related information sources are especially valuable for this purpose (see Chapter 2). To illustrate, the manufacturer of a component such as springs may reach industries incorporating the product into machine tools, bicycles, surgical devices, office equipment, telephones, and missile systems. Similarly, Intel’s microchips are used in household appliances, retail terminals, toys, cell phones, and aircraft as well as in computers. By isolating the specialized needs of each user group as identified by the NIACS category, the firm is better equipped to differentiate customer requirements and to evaluate emerging opportunities. Value in Use Strategic insights are also provided by exploring the value in use of various customer applications. Recall our discussion of value analysis in Chapter 2. Value in use is a product’s economic value to the user relative to a specific alternative in a particular application. The economic value of an offering frequently varies by customer application. Milliken & Company, the textile manufacturer, has built one of its businesses by becoming a major supplier of towels to industrial laundries. These customers pay Milliken a 10 percent premium over equivalent towels offered by competitors.11 Why? Milliken provides added value, such as a computerized routing program that improves the efficiency and effectiveness of the industrial laundries’ pick-up and delivery function. The segmentation strategy adopted by a manufacturer of precision motors further illuminates the value-in-use concept.12 The firm found that its customers differed in the motor speed required in their applications and that a dominant competitor’s new, low-priced machine wore out quickly in high- and medium-speed applications. The marketer concentrated on this vulnerable segment, demonstrating the superior life 10 Timothy M. Laseter, Balanced Sourcing: Cooperation and Competition in Supplier Relationships (San Francisco: Jossey-Bass, 1998), pp. 59–86. 11 Philip Kotler, “Marketing’s New Paradigm: What’s Really Happening Out There,” Planning Review 20 (September– October 1992): pp. 50–52. 12 Robert A. Garda, “How to Carve Niches for Growth in Industrial Markets,” Management Review 70 (August 1981): pp. 15–22. 130 Part III Assessing Market Opportunities TABLE 5.2 EXAMPLE OF MACROSEGMENTATION: AIRCRAFT INDUSTRY Macro Segment 1: Civilian Aircraft Sub-segments A. Airliners B. Cargo planes C. General aviation D. Agricultural aircraft E. Business aircraft F. Civilian Seaplane, Flying Boats, and Amphibious Aircraft G. Civilian Helicopters H. Sailplanes I. Civil Research Aircraft, Prototypes and Specials Macro Segment 2: Military Aircraft Sub-segments A. Bombers, Strike, Ground attack, gunships B. Patrol, Anti-Submarine and Electronic Warfare aircraft C. Military transports, tankers, and utility D. Reconnaissance aircraft E. Close air support/Counterinsurgency F. Fighter aircraft, nightfighters and heavy fighters G. Military Trainers H. Military Helicopters and autogyros I. Military Research Aircraft, Prototypes and Specials SOURCE: http://en.wikipedia.org/wiki/List_of_aircraft_by_category, June 2008. cycle cost advantages of the firm’s products. The marketer also initiated a long-term program to develop a competitively priced product and service offering for customers in the low-speed segment. Purchasing Situation A final macrolevel base for segmenting the organizational market is the purchasing situation. First-time buyers have perceptions and information needs that differ from those of repeat buyers. Therefore, buying organizations are classified as being in the early or late stages of the procurement process, or, alternatively, as new-task, straight rebuy, or modified rebuy organizations (see Chapter 3). The position of the firm in the procurement decision process or its location on the buying situation continuum dictates marketing strategy. These examples illustrate those macrolevel bases of segmentation that business marketers can apply to the organizational market. Other macrolevel bases may more precisely fit a specific situation. A key benefit of segmentation is that it forces the manager to search for bases that explain similarities and differences among buying organizations. Table 5.2 provides a view of how a manufacturer of aircraft engines might choose to segment the aircraft market from a macrosegmentation vantage point. Note that two very large macro segments exist—civilian and military. Within each of these large Chapter 5 TABLE 5.3 Segmenting the Business Market and Estimating Segment Demand 131 SELECTED MICROLEVEL BASES OF SEGMENTATION Variables Illustrative Breakdowns Key criteria Purchasing strategies Structure of decision-making unit Quality, delivery, supplier reputation Single source . . . multiple sources Major decision participants (for example, purchasing manager and plant manager) High importance . . . low importance Innovator . . . follower Importance of purchase Organizational innovativeness Personal characteristics Demographics Decision style Risk Confidence Job responsibility Age, educational background Normative, conservative, mixed mode Risk taker, risk avoider High . . . low Purchasing, production, engineering segments there are several very large macro subsegments. A jet engine manufacturer, like General Electric, would most likely begin the segmentation process in this fashion, looking carefully at the engine requirements for each of the several subsegments. The engine requirements in each segment may turn out to be very different, requiring different-size engines each capable of operating in very different conditions and environments. It could turn out that after detailed analysis of the needs in each subsegment, even further marcosegmentation may be necessary. For example, the “airliner” segment in the civilian macrosegment might be further segmented into regional jets versus full-size passenger jets. And then the full-size passenger jet airplane segment can be divided into specific types of aircraft, such as Boeing 737 or Airbus 340. Microlevel Bases Having identified macrosegments, the marketer often finds it useful to divide each macrosegment into smaller microsegments on the basis of the similarities and differences between decision-making units. Often, several microsegments—each with unique requirements and unique responses to marketing stimuli—are buried in macrosegments. To isolate them effectively, the marketer must move beyond secondary sources of information by soliciting input from the sales force or by conducting a special market segmentation study. Selected microbases of segmentation appear in Table 5.3. Key Criteria For some business products, the marketer can divide the market according to which criteria are the most important in the purchase decision.13 Criteria include product quality, prompt and reliable delivery, technical support, price, and supply continuity. The marketer also might divide the market based on supplier profiles 13 Schnedler, “Use Strategic Models,” pp. 85–92; and Kenneth E. Mast and Jon M. Hawes, “Perceptual Differences between Buyers and Engineers,” Journal of Purchasing and Materials Management 22 (Spring 1986): pp. 2–6; Donald W. Jackson Jr., Richard K. Burdick, and Janet E. Keith, “Purchasing Agents’ Perceived Importance of Marketing Mix Components in Different Industrial Purchase Situations,” Journal of Business Research 13 (August 1985): pp. 361–373; and Donald R. Lehmann and John O’Shaughnessy, “Decision Criteria Used in Buying Different Categories of Products,” Journal of Purchasing and Materials Management 18 (Spring 1982): pp. 9–14. 132 Part III Assessing Market Opportunities that appear to be preferred by decision makers (for example, high quality, prompt delivery, premium price versus standard quality, less-prompt delivery, low price). Illustration: Price versus Service14 Signode Corporation produces and markets a line of steel strapping used for packaging a range of products, including steel and many manufactured items. Facing stiff price competition and a declining market share, management wanted to move beyond traditional macrolevel segmentation to understand how Signode’s 174 national accounts viewed price versus service tradeoffs. Four segments were uncovered: 1. Programmed buyers (sales 5 $6.6 million): Customers who were not particularly price or service sensitive and who made purchases in a routine fashion—product is not central to their operation. 2. Relationship buyers (sales 5 $31 million): Knowledgeable customers who valued partnership with Signode and did not push for price or service concessions—product is moderately important to the firm’s operations. 3. Transaction buyers (sales 5 $24 million): Large and very knowledgeable customers who actively considered the price versus service trade-offs but often placed price over service—product is very important to their operations. 4. Bargain hunters (sales 5 $23 million): Large-volume buyers who were very sensitive to any changes in price or service—product is very important to their operations. The study enabled Signode to sharpen its strategies in this mature business market and to understand more clearly the cost of serving the various segments. Particularly troubling to management was the bargain-hunter segment. These customers demanded the lowest prices and the highest levels of service and had the highest propensity to switch. Management decided to use price cuts only as a defense against competitors’ cuts and directed attention instead at ways to add service value to this and other segments. Value-Based Strategies Many customers actively seek business marketing firms that can help them create new value to gain a competitive edge in their markets. Based on a comprehensive study of its customer base, Dow Corning identified three important customer segments and the value proposition that customers in each segment are seeking15: innovation-focused customers who are committed to being first to the market with new technologies and who seek new-product-development expertise and innovative solutions that will attract new customers; customers in fast-growing markets who are pressured by competitive battles over market growth and seek proven performance in technology, manufacturing, and supply chain management; customers in highly competitive markets who produce mature products, center on process efficiency and effectiveness in manufacturing, and seek cost-effective solutions that keep overall costs down. 14 V. Kasturi Rangan, Rowland T. Moriarty, and Gordon S. Swartz, “Segmenting Customers in Mature Industrial Markets,” Journal of Marketing 56 (October 1992): pp. 72–82. 15 Eric W. Balinski, Philip Allen, and J. Nicholas DeBonis, Value-Based Marketing for Bottom-Line Success (New York: McGraw-Hill and the American Marketing Association, 2003), pp. 147–152. Chapter 5 Segmenting the Business Market and Estimating Segment Demand 133 B2B TOP PERFORMERS Steering Customers to the Right Channel Dow Corning Corporation is the world’s largest and most innovative producer of silicone-based products. Although the leader in this large and diverse market, smaller, regional competitors began to take market share away from Dow Corning by selling low-priced silicone products with little or no technical support. Rather than paying for a host of high-quality services such as new-product-development assistance that Dow Corning customarily provides, these customers eagerly sought the lowest price. To meet the challenge, Dow Corning conducted a market segmentation study, isolated the characteristics of this “low-cost” buyer, and created a no-frills Web-based business model to reach this customer segment. To avoid confusion with existing customers and the firm’s premium product lines, a new brand was created—Xiameter (http://www .xiameter.com). To clarify the brand premise and the company connection, the tag line—“The new measure of value from Dow Corning”—was added. By steering pricesensitive customers to the Internet—a low-cost sales channel—the branding strategy allows Dow Corning “to compete head-on with the low-price suppliers of mature product lines, without damaging its position as a value-added leader at the premium price end of the market.” Customers, from the United States to high-growth potential countries like China, have responded positively to the Xiameter brand. (See the Dow Corning ad in Figure 5.1.) SOURCE: Bob Lamons, “Dow Targets Segment to Keep Market Share,” Marketing News, June 15, 2005, p. 8. See also Randall S. Rozin and Liz Magnusson, “Processes and Methodologies for Creating a Global Business-to-Business Brand,” Journal of Brand Management 10 (February 2003): pp. 185–207. The marketer can benefit by examining the criteria decision-making units in various sectors of the business market—commercial, governmental, and institutional—use. As organizations in each sector undergo restructuring efforts, the buying criteria key decision makers use also change. For example, the cost pressures and reform efforts in the health-care industry are changing how hospitals buy medical equipment and pharmaceuticals. To reduce administrative costs and enhance bargaining power, hospitals are following the lead of commercial enterprises by streamlining their operations. Also, they are forming buying groups, centralizing the purchasing function, and insisting on lower prices and better service. Reform efforts are likewise moving government buyers to search for more efficient purchasing procedures and for better value from vendors. Marketers that respond in this challenging environment are rewarded. Purchasing Strategies Microsegments can be classified according to buying organizations’ purchasing strategy. Some buyers seek to have several suppliers, giving each one a healthy share of their purchase volume; others are more interested in assured supply and concentrate their purchases with one or perhaps two suppliers. Raytheon, the manufacturer of small airplanes for the civilian and business aircraft market decided on a strategy of concentration. They rely on one firm—Castle Metals—to supply all of its needs for the different metals used in an aircraft. The company may reassess its sole supplier every so often, but any “out-supplier” in this situation would have a very difficult time securing some of Raytheon’s business. In another case, Toyota looks for suppliers who are able to make suggestions for improving its business operations. 134 Part III Assessing Market Opportunities FIGURE 5.1 AN AWARD-WINNING AD BY DOW CORNING FOR ITS WEB-BASED BUSINESS MODEL SOURCE: Reprinted by permission of XIAMETER. Toyota has realized that many of the innovations it has developed in its processes have come from suggestions by their suppliers. So a key strategy for Toyota is to identify suppliers who are creative and invest in new technology for possibly improving Toyota’s business. Chapter 5 Segmenting the Business Market and Estimating Segment Demand 135 Structure of the Decision-Making Unit The structure of the decision-making unit, or buying center, likewise provides a way to divide the business market into subsets of customers by isolating the patterns of involvement in the purchasing process of particular decision participants (for example, engineering versus top management). For the medical equipment market, DuPont initiated a formal positioning study among hospital administrators, radiology department administrators, and technical managers to identify the firm’s relative standing and the specific needs (criteria) for each level of buying influence within each segment.16 The growing importance of buying groups, multihospital chains, and nonhospital health-care delivery systems pointed to the need for a more refined segmentation approach. The study indicates that the medical equipment market can be segmented on the basis of the type of institution and the responsibilities of the decision makers and decision influencers in those institutions. The structure of the decision-making unit and the decision criteria used vary across the following three segments: • Groups that select a single supplier that all member hospitals must use, such as investor-owned hospital chains; • Groups that select a small set of suppliers from which individual hospitals may select needed products; • Private group practices and the nonhospital segment. Based on the study, DuPont’s salespersons can tailor their presentations to the decision-making dynamics of each segment. In turn, advertising messages can be more precisely targeted. Such an analysis enables the marketer to identify meaningful microsegments and respond with finely tuned marketing communications. Importance of Purchase Classifying organizational customers on the basis of the perceived importance of a product is especially appropriate when various customers apply the product in various ways. Buyer perceptions differ according to the effect of the product on the total mission of the firm. A large commercial enterprise may consider the purchase of consulting services routine; the same purchase for a small manufacturing concern is “an event.” Organizational Innovativeness Some organizations are more innovative and willing to purchase new industrial products than others. A study of the adoption of new medical equipment among hospitals found that psychographic variables can improve a marketer’s ability to predict the adoption of new products.17 These include such factors as an organization’s level of change resistance or desire to excel. When psychographic variables are combined with organizational demographic variables (for example, size), accuracy in predicting organizational innovativeness increases. Because products diffuse more rapidly in some segments than in others, microsegmentation based on organizational innovativeness enables the marketer to identify segments that should be targeted first when it introduces new products. The accuracy 16 Gary L. Coles and James D. Culley, “Not All Prospects Are Created Equal,” Business Marketing 71 (May 1986): pp. 52–57. 17 Thomas S. Robertson and Yoram Wind, “Organizational Psychographics and Innovativeness,” Journal of Consumer Research 7 (June 1980): pp. 24–31; see also Thomas S. Robertson and Hubert Gatignon, “Competitive Effects on Technology Diffusion,” Journal of Marketing 50 (July 1986): pp. 1–12. 136 Part III Assessing Market Opportunities of new product forecasting also improves when diffusion patterns are estimated segment by segment.18 Personal Characteristics Some microsegmentation possibilities deal with the personal characteristics of decision makers: demographics (age, education), personality, decision style, risk preference or risk avoidance, confidence, job responsibilities, and so forth. Although some interesting studies have shown the usefulness of segmentation based on individual characteristics, further research is needed to explore its potential as a firm base for microsegmentation. Illustration: Microsegmentation19 Philips Lighting Company, the North American division of Philips Electronics, found that purchasing managers emphasize two criteria in purchasing light bulbs: how much they cost and how long they last. Philips learned, however, that the price and life of bulbs did not account for the total cost of lighting. Because lamps contain environmentally toxic mercury, companies faced high disposal costs at the end of a lamp’s useful life. New Product and Segmentation Strategy To capitalize on a perceived opportunity, Philips introduced the Alto, an environmentally friendly bulb that reduces customers’ overall costs plus allows the buying organization to demonstrate environmental concern to the public. Rather than targeting purchasing managers, Philips’s marketing strategists centered attention on chief financial officers (CFOs), who embraced the cost savings, and public relations executives, who saw the benefit of purchasing actions that protect the environment. By targeting different buying influentials, Philips created a new market opportunity. In fact, the Alto has already replaced more than 25 percent of traditional fluorescent lamps in U.S. stores, schools, and office buildings. The Segmentation Process Macrosegmentation centers on characteristics of buying organizations (for example, size), product application (for example, end market served), and the purchasing situation (for example, stage in the purchase decision process). Microsegmentation concentrates on characteristics of organizational decision-making units—for instance, choice criteria assigned the most importance in the purchase decision. Choosing Market Segments Business marketers begin the segmentation process at the macro level. If they find that the information about the macro segments is sufficient to develop an effective 18 Yoram Wind, Thomas S. Robertson, and Cynthia Fraser, “Industrial Product Diffusion by Market Segment,” Industrial Marketing Management 11 (February 1982): pp. 1–8. 19 W. Chan Kim and Renée Mauborgne, “Creating New Market Space,” Harvard Business Review 77 (January–February 1999): pp. 88–89. For other segmentation studies, see Mark J. Bennion Jr., “Segmentation and Positioning in a Basic Industry,” Industrial Market Management 16 (February 1987): pp. 9–18; Arch G. Woodside and Elizabeth J. Wilson, “Combining Macro and Micro Industrial Market Segmentation,” in Advances in Business Marketing, ed. Arch G. Woodside (Greenwich, CT: JAI Press, 1986), pp. 241–257; and Peter Doyle and John Saunders, “Market Segmentation and Positioning in Specialized Industrial Markets,” Journal of Marketing 49 (Spring 1985): pp. 24–32. Chapter 5 Segmenting the Business Market and Estimating Segment Demand 137 INSIDE BUSINESS MARKETING A Fresh Approach to Segmentation: Customer Service Segmentation Conceptually, customer service segmentation involves identifying groups of customers for which a company will provide types and levels of service. It works on the premise that the service requirements, as well as the associated cost-toserve and profit potential, vary by customer tier. The exhibit shows the differentiated services that are aligned with each customer segment. The lowest-tier customers require the basic services, some special services are added for midtier customers, and top-tier customers get the complete service assortment plus some high-level value-added services. Service-segment alignments are depicted as double-sided arrows in the exhibit to represent the point that customer needs and service offerings are aligned in accordance with strategic “pushpull” objectives. The goal is to develop a customer service strategy that responds to the unique requirements of particular segments, maintains a tight grasp on costs, and advances profit growth by segment. SOURCE: Larry Lapide, “Segment Strategically,” Supply Chain Management Review 12 (5, May/June 2008): pp. 8–9. Illustrative Customer Segmentation & Differentiated Services Alignment Differentiated Services High Tier Services • Sharing of downstream data (e.g., POS) • Sharing of replenishment plans and sales forecasts • Co-managed inventory programs Mid-Tier Services • Special handling and packaging • Reduced delivery cycle times • Full-truckload discounts Basic Services • Standard delivery cycle time • Standard handling and packaging Customer Services Alignment Alignment Alignment TopTier MidTier LowestTier marketing strategy, then it may not be necessary to go on to any further micrcosegmentation. However, if they cannot develop a distinct strategy based on the macrosegment, then it may be necessary to undertake research on microsegmentation variables within each macrosegment. A marketing research study is often needed to identify characteristics of decision-making units, as the Philips Lighting case illustrated. At this level, chosen macrosegments are divided into microsegments on the basis of similarities and differences between the decision-making units to identify small groups of buying organizations that each exhibit a distinct response to the firm’s marketing strategy. As firms develop more segments with special requirements, it 138 Part III Assessing Market Opportunities then becomes necessary to assess whether the cost of developing a unique strategy for a specific segment is worth the profit to be generated from that segment. The marketer must evaluate the potential profitability of alternative segments before investing in separate marketing strategies. As firms develop a clearer picture of the revenue and costs of serving particular segments and customers, they often find that a small group of customers subsidizes a large group of marginal and, in some cases, unprofitable customers.20 (See Chapter 4.) In some cases it may be more effective to examine existing customers in a new light. As A. G. Lafley and Lam Charam note, “segmentation itself can be an innovative act, if we identify a corner of our market that is rarely treated as a segment. Can we look at buyers through some other lens than typical tried and true variables like company size and industry? Identifying an overlooked segment is less expensive than inventing a new technology and may sprout even more opportunities.”21 One interesting approach in business-to-business marketing today is the rise of account-based marketing (ABM), perhaps the ultimate expression of the trend toward smaller and more precisely targeted marketing strategies. ABM is an approach that treats an individual account as a market in its own right. Done right, it ensures that marketing and sales are fully focused on a target client’s most important business issues and that they work collaboratively to create value propositions that specifically address those issues. Far beyond the basics of personalized messaging and segmented offers, true ABM has the potential to deepen relationships with existing clients and build profitability by shortening the sales cycle and increasing win rates and solesourced contracts.22 ABM is the ultimate in segmentation, as one company is viewed as a separate segment. This approach may become more prevalent in the future as industry consolidation continues to grow. One could see the commercial aircraft industry as a good example of this ultimate level of segmentation—only two companies now produce large, commercial airliners: Boeing and Airbus S.A.S. Similarly, in the diesel locomotive industry in the United States, only General Motors and General Electric make diesel locomotives. Isolating Market Segment Profitability To improve on traditional market segmentation, many business marketing firms categorize customers into tiers that differ in current and/or future profitability to the firm. “By knowing the characteristics of profitable customers, companies can direct their marketing efforts to specific segments that are most likely to yield profitable customers.”23 This requires a process of evaluation that makes explicit the near-term potential and the longer-term resource commitments necessary to effectively serve customers in a segment. In particular, special attention is given to the individual drivers of customer profitability, namely the cost-to-serve a particular group of customers and the revenues that result (see Chapter 4). 20 Arun Sharma, R. Krishnan, and Dhruv Grewal, “Value Creation in Markets: A Critical Area of Focus for Business- to-Business Markets,” Industrial Marketing Management 30 (June 2001): pp. 391–402. 21 A.G. Lafley and Ram Charan, “Making Inspiration Routine,” Inc 30 (6, June 2008): pp. 98–101. 22 Jeff Sands, “Account-Based Marketing,” B to B, 91 (6, May 8, 2006): p. 11. 23 Robert S. Kaplan and V. G. Narayanan, “Measuring and Managing Customer Profitability,” Journal of Cost Management 15 (September–October 2001): p. 13. Chapter 5 Segmenting the Business Market and Estimating Segment Demand 139 FedEx Corporation, for example, categorizes its business customers (for internal purposes) as the good, the bad, and the ugly—based on their profitability.24 Rather than using the same strategy for all customers, the company assigns a priority to the good, tries to convert the bad to good, and discourages the ugly. Like many other firms, FedEx discovered that many customers are too costly to serve and demonstrate little potential to become profitable, even in the long term. By understanding the needs of customers at different tiers of profitability, service can be tailored to achieve even higher levels of profitability. For example, FedEx encourages small shippers to bring their packages to conveniently located drop-off points and offers a rapid-response pick-up service for large shippers. Once profitability tiers are identified, “highly profitable customers can be pampered appropriately, customers of average profitability can be cultivated to yield higher profitability, and unprofitable customers can be either made more profitable or weeded out.”25 Implementing a Segmentation Strategy A well-developed segmentation plan will fail without careful attention to implementing the plan. Successful implementation requires attention to the following issues: • How should the sales force be organized? • What special technical or customer service requirements will organizations in the new segment have? • Who will provide these services? • Which media outlets can be used to target advertising at the new segment? • Has a comprehensive online strategy been developed to provide continuous service support to customers in this segment? • What adaptations will be needed to serve selected international market segments? The astute business marketing strategist must plan, coordinate, and monitor implementation details. Frank Cespedes points out that “as a firm’s offering becomes a product-service-information mix that must be customized for diverse segments, organizational interdependencies increase”26 and marketing managers, in particular, are involved in more cross-functional tasks. Managing the critical points of contact with the customer is fundamental to the marketing manager’s role. Estimating Segment Demand Looking back at the Internet boom, executives at telecommunications firms like Alcatel-Lucent and Nortel Networks Corporation now openly acknowledge that they did not see the steep drop in demand coming. Indeed, spending by phone companies 24 R. Brooks, “Alienating Customers Isn’t Always a Bad Idea, Many Firms Discover,” The Wall Street Journal, January 7, 1999, pp. A1 and A12, discussed in Valarie A. Zeithaml, Roland T. Rust, and Katherine N. Lemon, “The Customer Pyramid: Creating and Serving Profitable Customers,” California Management Review 43 (Summer 2001): p. 118. 25 Zeithaml, Rust, and Lemon, “The Customer Pyramid,” p. 141. 26 Frank V. Cespedes, Concurrent Marketing: Integrating Product, Sales, and Service (Boston: Harvard Business School Press, 1995), p. 271. 140 Part III Assessing Market Opportunities on telecommunications gear nearly doubled from 1996 to 2000, to $47.5 billion; all forecasts indicated that this attractive growth path would continue.27 During this period, telecom equipment makers were dramatically expanding production capacity and aggressively recruiting thousands of new employees. However, in 2001, the demand failed to materialize and the major telecom equipment makers reported significant financial losses. In turn, firms across the industry announced a series of massive job cuts. What happened? “Lousy” sales forecasts played an important role, according to Gregory Duncan, a telecom consultant at National Economic Research Associates.28 The Role of the Demand Estimation Estimating demand within selected market segments is vital to marketing management. The forecast of demand reflects management’s estimate of the probable level of company sales, taking into account both potential business and the level and type of marketing effort demanded. Virtually every decision made by the marketer is based on a forecast, formal or informal. Consider a company that wishes to introduce new telecommunications services to businesses. How large is the market opportunity? An estimate of demand provides the foundation for the planning process. Three broad groups of stakeholders require demand forecasts: engineering design and implementation teams; marketing and commercial development teams; and external entities, such as potential investors, government regulators, equipment and application suppliers, and distribution partners. In the marketing area, commercial questions that must be answered before launch of service and that depend on the estimate of demand include: Where should sales outlets be located? How many are required to cover the target market? What sales levels should be expected from each outlet? What performance targets should be established for each? Demand forecasts are needed to project the company’s revenues, profits, and cash flow to assess business viability; to determine cash, equity, and borrowing requirements; and to determine appropriate pricing structures and levels.29 In short, without knowledge of market demand, marketing executives cannot develop sound strategy and make effective decisions about the allocation of resources. A primary application of the estimates of demand is clearly in the planning and control of marketing strategy by market segment. Once demand is estimated for each segment, the manager can allocate expenditures on the basis of potential sales volume. Spending huge sums of money on advertising and personal selling has little benefit in segments where the market opportunity is low. Of course, expenditures would have to be based on both expected demand and the level of competition. Actual sales in each segment can also be compared with forecasted sales, taking into account the level of competition, in order to evaluate the effectiveness of the marketing program. Consider the experience of a Cleveland manufacturer of quick-connective couplings for power transmission systems. For more than 20 years, one of its large distributors had been increasing its sales volume. In fact, this distributor was considered one of the firm’s top producers. The manufacturer then analyzed the estimates of demand for each of its 31 distributors. The large distributor ranked thirty-first in 27 Dennis K. Berman, “’Lousy Sales Forecasts Helped Fuel the Telecom Mess,” The Wall Street Journal, July 7, 2001, p. B1. 28 Ibid. 29 Peter McBurney, Simon Parsons, and Jeremy Green, “Forecasting Market Demand for New Telecommunications Services: An Introduction,” Telematics and Information 19 (2002): p. 233. Chapter 5 Segmenting the Business Market and Estimating Segment Demand 141 INSIDE BUSINESS MARKETING Accurate Forecasts Drive Effective Collaboration between Boeing and Alcoa Alcoa supplies raw aluminum to Boeing for constructing wings for most of Boeing’s commercial airplanes. As a result of sharing accurate demand data with Alcoa, Boeing was able to achieve cost reductions and improve delivery-time performance throughout the entire supply chain. Boeing began by developing an electronic sales forecast to allow Alcoa to receive the forecast file directly into its system. Included in the forecast are all the data Alcoa needed to understand the demand for the raw aluminum to be used in constructing aircraft wings. The forecast data were provided so that they could be loaded into Alcoa’s system in an efficient manner, and great emphasis was placed on forecast accuracy. Because forecast errors would totally undermine the supply process, Boeing developed a process to identify errors in demand before communicating the forecasts electronically to Alcoa. Boeing provides Alcoa with electronic visibility into its ERP (Enterprise Resource Planning) System so that Alcoa can understand when orders will be coming and can thereby respond more effectively to Boeing’s needs. In short, Boeing realized that for Alcoa to make decisions on when it should have materials in Boeing’s plant, Alcoa had to be given the most accurate forecast data possible. In working together in the supply chain, the electronic sharing of demand forecasts made it possible for Alcoa to maintain the appropriate levels of aluminum inventory to meet Boeing’s requirements. SOURCE: Adapted from Victoria A. Micheau, “How Boeing and Alcoa Implemented a Successful Vendor Managed Inventory Program,” Journal of Business Forecasting 24 (Spring 2005): pp. 17–19. terms of volume relative to potential business, achieving only 15.4 percent of estimated demand. A later evaluation revealed that the distributor’s sales personnel did not know the most effective way to sell couplings to its large-customer accounts. It is important to keep in mind that estimates of probable demand should be made only after the firm has made decisions about its marketing strategy for a particular segment. Only after the marketing strategy is developed can expected sales be forecasted. Many firms are tempted to use the forecast as a tool for deciding the level of marketing expenditures. One study (which sampled 900 firms) found that slightly more than 25 percent of the respondent firms set their advertising budgets after the forecast of demand was developed.30 Small companies whose budgeting and forecasting decisions were fragmented made up the majority of the firms in this group. Clearly, marketing strategy is a determinant of the level of sales and not vice versa. Supply Chain Links Sales forecasts are critical to the smooth operation of the entire supply chain. When timely sales forecast information is readily available to all firms in the supply chain, plans can be tightly coordinated and all parties share in the benefits.31 Sales forecast data is used to distribute inventory in the supply chain, manage stock levels at each link, and schedule resources for all the members of a supply 30 Douglas C. West, “Advertising Budgeting and Sales Forecasting: The Timing Relationship,” International Journal of Advertising 14 (1, 1995): pp. 65–77. 31 John T. Mentzer and Mark A. Moon, “Understanding Demand,” Supply Chain Management Review 8 (May–June 2004): p. 45. 142 Part III Assessing Market Opportunities chain that provide materials, components, and services to a manufacturer. Accurate forecasts go hand-in-hand with good business practices and effective management policies in directing the entire supply chain process. Specific tools are available to develop accurate estimates of market potential; the business marketer must understand the purpose of each alternative technique as well as its strengths and limitations. Methods of Forecasting Demand Estimating demand may be highly mathematical or informally based on sales force estimates. Two primary approaches to demand forecasting are recognized: (1) qualitative and (2) quantitative, which includes time series and causal analysis. Qualitative Techniques Qualitative techniques, which are also referred to as management judgment or subjective techniques rely on informed judgment and rating schemes. The sales force, top-level executives, or distributors may be called on to use their knowledge of the economy, the market, and the customers to create qualitative demand estimates. Techniques for qualitative analysis include the executive judgment method, the sales force composite method, and the Delphi method. The effectiveness of qualitative approaches depends on the close relationships between customers and suppliers that are typical in the industrial market. Qualitative techniques work well for such items as heavy capital equipment or when the nature of the forecast does not lend itself to mathematical analysis. These techniques are also suitable for new-product or new-technology forecasts when historical data are scarce or nonexistent.32 An important advantage of qualitative approaches is that it brings users of the forecast into the forecasting process. The effect is usually an increased understanding of the procedure and a higher level of commitment to the resultant forecast. Executive Judgment According to a large sample of business firms, the executive judgment method enjoys a high level of usage.33 The judgment method, which combines and averages top executives’ estimates of future sales, is popular because it is easy to apply and to understand. Typically, executives from various departments, such as sales, marketing, production, finance, and purchasing, are brought together to apply their collective expertise, experience, and opinions to the forecast. The primary limitation of the approach is that it does not systematically analyze cause-and-effect relationships. Further, because there is no established formula for deriving estimates, new executives may have difficulty making reasonable forecasts. The resulting forecasts are only as good as the executives’ opinions. The accuracy of the executive judgment approach is also difficult to assess in a way that allows meaningful comparison with alternative techniques.34 The executives’ “ballpark” estimates for the intermediate and the long-run time frames are often used in conjunction with forecasts developed quantitatively. 32 A. Michael Segalo, The IBM/PC Guide to Sales Forecasting (Wayne, PA: Banbury, 1985), p. 21. 33 Nada Sanders, “Forecasting Practices in U.S. Corporations: Survey Results,” Interfaces 24 (March–April 1994): pp. 92–100. 34 Spyros Makridakis and Steven Wheelwright, “Forecasting: Issues and Challenges for Marketing Management,” Journal of Marketing 41 (October 1977): p. 31. Chapter 5 Segmenting the Business Market and Estimating Segment Demand 143 However, when historical data are limited or unavailable, the executive judgment approach may be the only alternative. Mark Moriarty and Arthur Adams suggest that executive judgment methods produce accurate forecasts when (1) forecasts are made frequently and repetitively, (2) the environment is stable, and (3) the linkage between decision, action, and feedback is short.35 Business marketers should examine their forecasting situation in light of these factors in order to assess the usefulness of the executive judgment technique. Sales Force Composite The rationale behind the sales force composite approach is that salespeople can effectively estimate future sales volume because they know the customers, the market, and the competition. In addition, participating in the forecasting process helps sales personnel understand how forecasts are derived and boosts their incentive to achieve the desired level of sales. The composite forecast is developed by combining the sales estimates from all salespeople. By providing the salesperson with a wealth of customer information that can be conveniently accessed and reviewed, customer relationship management (CRM) systems (see Chapter 4) enhance the efficiency and effectiveness of the sales force composite.36 CRM systems also allow a salesperson to track progress in winning new business at key accounts. Few companies rely solely on sales force estimates; rather, they usually adjust or combine the estimates with forecasts developed either by top management or by quantitative methods. The advantage of the sales force composite method is the ability to draw on sales force knowledge about markets and customers. This advantage is particularly important for a market in which buyer-seller relationships are close and enduring. The salesperson is often the best source of information about customer purchasing plans and inventory levels. The method can also be executed relatively easily at minimal cost. An added benefit is that creating a forecast forces a sales representative to carefully review these accounts in terms of future sales.37 The problems with sales force composites are similar to those of the executive judgment approach: They do not involve systematic analysis of cause and effect, and they rely on informed judgment and opinions. Some sales personnel may overestimate sales in order to look good or underestimate them in order to generate a lower quota. Management must carefully review all estimates. As a rule, sales force estimates are relatively accurate for short-run projections but less effective for longterm forecasts. Delphi Method In the Delphi approach to forecasting, the opinions of a panel of experts on future sales are converted into an informed consensus through a highly structured feedback mechanism.38 As in the executive judgment technique, 35 Mark M. Moriarty and Arthur J. Adams, “Management Judgment Forecasts, Composite Forecasting Models and Conditional Efficiency,” Journal of Marketing Research 21 (August 1984): p. 248. 36 Robert Mirani, Deanne Moore, and John A. Weber, “Emerging Technologies for Enhancing Supplier-Reseller Partnerships,” Industrial Marketing Management 30 (February 2001): pp. 101–114. 37 Stewart A. Washburn, “Don’t Let Sales Forecasting Spook You,” Sales and Marketing Management 140 (September 1988): p. 118. 38 Raymond E. Willis, A Guide to Forecasting for Planners and Managers (Englewood Cliffs, NJ: Prentice-Hall, 1987), p. 343. 144 Part III Assessing Market Opportunities management officials are used as the panel, but each estimator remains anonymous. On the fi rst round, written opinions about the likelihood of some future event are sought (for example, sales volume, competitive reaction, or technological breakthroughs). The responses to this fi rst questionnaire are used to produce a second. The objective is to provide feedback to the group so that first-round estimates and information available to some of the experts are made available to the entire group. After each round of questioning, the analyst who administers the process assembles, clarifies, and consolidates information for dissemination in the succeeding round. Throughout the process, panel members are asked to reevaluate their estimates based on the new information from the group. Opinions are kept anonymous, eliminating both “me-too” estimates and the need to defend a position. After continued reevaluation, the goal is to achieve a consensus. The number of experts varies from six to hundreds, depending on how the process is organized and its purpose. The number of rounds of questionnaires depends on how rapidly the group reaches consensus. Generally, the Delphi technique is applied to long-term forecasting of demand, particularly for new products or situations not suited to quantitative analysis. This approach can provide some good ballpark estimates of demand when the products are new or unique and when there is no other data available. Like all qualitative approaches to estimating demand, it is difficult to measure the accuracy of the estimates. Qualitative forecasting approaches are important in the process of assessing future product demand, and they are most valuable in situations where little data exists and where a broad estimate of demand is acceptable. New or unique products do not lend themselves to more quantitative approaches to forecasting, so the qualitative methods play a very important role in estimating demand for these items. Quantitative Techniques Quantitative demand forecasting, also referred to as systematic or objective forecasting, offers two primary methodologies: (1) time series and (2) regression or causal. Time series techniques use historical data ordered chronologically to project the trend and growth rate of sales. The rationale behind time series analysis is that the past pattern of sales will apply to the future. However, to discover the underlying pattern of sales, the analyst must first understand all of the possible patterns that may affect the sales series. Thus, a time series of sales may include trend, seasonal, cyclical, and irregular patterns. Once the effect of each has been isolated, the analyst can then project the expected future of each pattern. Time series methods are well suited to short-range forecasting because the assumption that the future will be like the past is more reasonable over the short run than over the long run.39 Regression or causal analysis, on the other hand, uses an opposite approach, identifying factors that have affected past sales and implementing them in a mathematical model.40 Demand is expressed mathematically as a function of the items 39 Spyros Makridakis, “A Survey of Time Series,” International Statistics Review 44 (1, 1976): p. 63. 40 Segalo, Sales Forecasting, p. 27. Chapter 5 Segmenting the Business Market and Estimating Segment Demand 145 that affect it. A forecast is derived by projecting values for each of the factors in the model, inserting these values into the regression equation, and solving for expected sales. Typically, causal models are more reliable for intermediate than for long-range forecasts because the magnitude of each factor affecting sales must first be estimated for some future time, which becomes difficult when estimating farther into the future. The specifics of the quantitative approaches to estimating demand are beyond the scope of this chapter. However, the key aspects of these approaches for the businessto-business manager to keep in mind are as follows: 1. To develop an estimate of demand with time series analysis, the analyst must determine each pattern (the trend, cycle, seasonal pattern) and then extrapolate them into the future. This requires a significant amount of historical sales information. Once a forecast of each pattern is developed, the demand forecast is assembled by combining the estimates for each pattern. 2. A critical aspect of regression analysis is to identify the economic variable(s) to which past sales are related. For forecasting purposes, the Survey of Current Business is particularly helpful because it contains monthly, quarterly, and annual figures for hundreds of economic variables. The forecaster can test an array of economic variables from the Survey to find the variable(s) with the best relationship to past sales. 3. Although causal methods have measurable levels of accuracy, there are some important caveats and limitations. The fact that demand and some causal variables (independent variables) are correlated (associated) does not mean that the independent variable “caused” sales. The independent variable should be logically related to demand. 4. Regression methods require considerable historical data for equations to be valid and reliable, but the data may not be available. Caution must always be used in extrapolating relationships into the future. The equation relates what has happened; economic and industry factors may change in the future, making past relationships invalid. 5. A recent study on forecasting methods suggests choosing a methodology based on the underlying behavior of the market rather than the time horizon of the forecast.41 This research indicates that when markets are sensitive to changes in market and environmental variables, causal methods work best, whether the forecast is short or long range; time series approaches are more effective when the market exhibits no sensitivity to market and/or environmental changes. CPFR: A New Collaborative Approach to Estimating Demand CPFR, or Collaborative Planning Forecasting and Replenishment, is a unique approach to forecasting demand that involves the combined efforts of many functions 41 Robert J. Thomas, “Method and Situational Factors in Sales Forecast Accuracy,” Journal of Forecasting 12 (January 1993): p. 75. 146 Part III Assessing Market Opportunities within the firm as well as with partners in the supply chain. In this approach, one individual in the firm is given the responsibility for coordinating the forecasting process with functional managers across the firm. So sales, marketing, production, logistics, and procurement personnel will be called upon to jointly discuss their plans for the upcoming period. In this way, all the parties who may influence sales performance will participate directly in the demand estimation process. Once the firm has a good grasp internally of each function’s forthcoming strategies and plans, the “demand planner” from the firm will then reach out to customers, distributors, and manufacturers’ representatives to assess what their marketing, promotion, and sales plans are for the product in question. These plans are then shared with the company’s functional managers and demand estimates are adjusted accordingly. The demand planner then develops a final demand estimate for the coming period based on this wide array of input. As one might expect, the CPFR approach to estimating demand often results in a very accurate forecast of demand due to the intensive sharing of information among the firm’s functional managers and key supply chain and channel partners. The most practical approach for application of CPFR is for the trading partners to map their partners’ forecasts into their own terms, understand where their partners’ plans deviate significantly from their own, and then collaborate on the assumptions that may be leading to different estimates. Through this iterative process, intermediaries and manufacturers use collaborative feedback to synchronize their supply chains, while keeping their enterprise planning processes intact.42 Combining Several Forecasting Techniques Recent research on forecasting techniques indicates that forecasting accuracy can be improved by combining the results of several forecasting methods.43 The results of combined forecasts greatly surpass most individual projections, techniques, and analyses by experts. Mark Moriarty and Arthur Adams suggest that managers should use a composite forecasting model that includes both systematic (quantitative) and judgmental (qualitative) factors.44 In fact, they suggest that a composite forecast be created to provide a standard of comparison in evaluating the results provided by any single forecasting approach. Each forecasting approach relies on varying data to derive sales estimates. By considering a broader range of factors that affect sales, the combined approach provides a more accurate forecast. Rather than searching for the single “best” forecasting technique, business marketers should direct increased attention to the composite forecasting approach. 42 “Taking It One Step at a Time: Tapping into the Benefits of Collaborative Planning, Forecasting, and Replenishment (CPFR),” An Oracle White Pape, (August 2005), http://www.oracle.com/applications/retail/library/white-papers/takingit-one-step.pdf. 43 J. Scott Armstrong, “The Forecasting Canon: Nine Generalizations to Improve Forecast Accuracy,” FORESIGHT: The International Journal of Applied Forecasting 1 (1, June 2005): pp. 29–35. 44 Moriarty and Adams, “Management Judgment Forecasts,” p. 248. Chapter 5 Segmenting the Business Market and Estimating Segment Demand 147 Summary The business market contains a complex mix of customers with diverse needs and objectives. The marketing strategist who analyzes the aggregate market and identifies neglected or inadequately served groups of buyers (segments) is ideally prepared for a market assault. Specific marketing strategy adjustments can be made to fit the unique needs of each target segment. Of course, such differentiated marketing strategies are feasible only when the target segments are measurable, accessible, compatible, responsive, and large enough to justify separate attention. Procedurally, business market segmentation involves categorizing actual or potential buying organizations into mutually exclusive clusters (segments), each of which exhibits a relatively homogeneous response to marketing strategy variables. To accomplish this task, the business marketer can draw upon two types of segmentation bases: macrolevel and microlevel. Macrodimensions are the key characteristics of buying organizations and of the purchasing situation. The NAICS together with other secondary sources of information are valuable in macrolevel segmentation. Microlevel bases of segmentation center on key characteristics of the decision-making unit and require a higher level of market knowledge. This chapter outlined a systematic approach for the business marketer to apply when identifying and selecting target segments. Before a final decision is made, the marketer must weigh the costs and benefits of a segmented marketing strategy. In developing a market segmentation plan, the business marketing manager isolates the costs and revenues associated with serving particular market segments. By directing its resources to its most profitable customers and segments, the business marketer is less vulnerable to focused competitors that may seek to “cherry-pick” the firm’s most valuable customers. The forecasting techniques available to the business marketer are (1) qualitative and (2) quantitative. Qualitative techniques rely on informed judgments of future sales and include executive judgment, the sales force composite, and the Delphi methods. By contrast, quantitative techniques have more complex data requirements and include time series and causal approaches. The time series method uses chronological historical data to project the future trend and growth rate of sales. Causal methods, on the other hand, seek to identify factors that have affected past sales and to incorporate them into a mathematical model. The essence of sound demand forecasting is to combine effectively the forecasts provided by various methods. Discussion Questions 1. Cogent is a rapidly growing company that makes software which identifies people using biometrics—fingerprints, faces, eyeballs, and other personal characteristics. The firm is making terminals that allow customers to pay for products with their fingerprints. Assess the potential of the “pay by touch” system and suggest possible market segments that might be receptive to the new offering. 2. Automatic Data Processing, Inc. (ADP), handles payroll and tax filing processing for more than 300,000 customers. In other words, firms outsource these functions to ADP. Suggest possible segmentation bases that ADP might employ in this service market. What criteria would be important to organizational buyers in making the decision to turn payroll processing over to an outside firm? 148 Part III Assessing Market Opportunities 3. FedEx believes that its future growth will come from business-tobusiness e-commerce transactions where customers demand quick and reliable delivery service. Outline a segmentation plan that the firm might use to become the market leader in this rapidly expanding area. 4. Sara Lee Corporation derives more than $1.5 billion of sales each year from the institutional market (for example, hospitals, schools, restaurants). Explain how a firm such as Sara Lee or General Mills might apply the concept of market segmentation to the institutional market. 5. Some firms follow a single-stage segmentation approach using macrodimensions; others use both macrodimensions and microdimensions. As a business marketing manager, what factors would you consider in making a choice between the two methods? 6. Compare and contrast the sales force composite and the Delphi methods of developing a sales forecast. 7. Although qualitative forecasting techniques are important in the sales forecasting process in many industrial firms, the marketing manager must understand the limitations of these approaches. Outline these limitations. 8. As alternative methods for demand forecasting, what is the underlying logic of (1) time series and (2) regression or causal methods? 9. What limitations must be understood before applying and interpreting the demand forecasting results generated by causal methods? 10. What features of the business market support the use of qualitative forecasting approaches? What benefits does the business market analyst gain by combining these qualitative approaches with quantitative forecasting methods? Internet Exercises 1. Xerox positions itself as “The Document Company” because the firm provides solutions to help customers manage documents—paper, electronic, online. Go to http://www.xerox.com, click on “Industry Solutions,” and a. Describe the industry sectors that the firm seems to cover in its market segmentation plan. b. Identify the particular product and service that Xerox has developed for bank customers. CASE Federated Insurance: Targeting Small Businesses45 Targeting small and medium-sized business (SMB) customers, Federated Insurance offers clients and prospects a program of complete insurance protection, covering the spectrum from commercial property and casualty insurance and life and disability insurance to group health insurance. Since its founding over a century ago, the market plan for the company has centered on a clear-cut strategy: provide the highest quality, best-value service available to selected businesses. Based in Owatonna, Minnesota, with regional offices in Atlanta and Phoenix, Federated has 2,600 employees and operates in 48 states. Consistent with its heritage and original market plan, the company specializes in business insurance for selected industries: • Auto dealers and auto parts wholesalers • Building contractors (for example, electrical, plumbing-heating-cooling) • Equipment dealers (for example, agricultural, lawn and garden) • Funeral services • Jewelers • Machine shops • Petroleum marketers and convenience stores • Tire dealers Cultivating Business Relationships Marketing representatives at Federated can tailor insurance protection to meet virtually all of a business owner’s insurance needs: property, casualty, health, retirement, and more. They also provide quality risk-management services that respond to the specific needs of business owners. The goal here is to help customers develop procedures and practices that can reduce losses and improve worksite safety conditions. Federated enjoys a strong reputation among SMB customers, as the following testimonials demonstrate: “One of the things Federated does very well is that they have focus. It’s not about selling insurance, it’s about taking care of your customers, and the businesses that do best are the ones that take care of their customers.” [Tim Smith, President, Bob Smith BMW, Calabasas, California] 45 “About Federated: Our History and Mission,” accessed at http://www.federatedinsurance.com on July 10, 2008. 149 150 Part III Assessing Market Opportunities “I’ve had friends who are in businesses that jump insurance companies all the time and they’re price shopping. They don’t realize the relationship that you have to build with an insurance company. It’s such a close relationship, but yet so secure. With Federated, we don’t worry—we don’t have to.” [Greg Nesler, President, Rochester Plumbing and Heating, Rochester, Minnesota] Discussion Questions 1. By directing attention to particular types of businesses (for example, convenience stores or auto dealers), Federated emphasizes macrosegmentation. To further sharpen strategy, suggest possible ways that particular macrosegments could be broken down further into meaningful microsegments. 2. In buying insurance, some SMB customers just want the lowest-priced option for each type of insurance, whereas others want value-added services (for example, risk-management guidance) and a complete, integrated insurance solution. How should Federated respond to customers who are strictly focused on price? In your view, what are the points of difference that Federated should illuminate in the customer value proposition? PART IV FORMULATING BUSINESS MARKETING STRATEGY 151 This page intentionally left blank CHAPTER 6 Business Marketing Planning: Strategic Perspectives To this point, you have developed an understanding of organizational buying behavior, customer relationship management, market segmentation, and a host of other tools managers use. All of this provides a fundamentally important perspective to the business marketing strategist. After reading this chapter, you will understand: 1. marketing’s strategic role in corporate strategy development. 2. the multifunctional nature of business marketing decision making. 3. the components of a business model that can be converted into superior positions of advantage in the business market. 4. a valuable framework for detailing the processes and systems that drive strategy success. 153 154 Part IV Formulating Business Marketing Strategy Most large corporations implicitly believe that strategy is the province of senior management. This is not so at GE Capital.1 At a recent planning session, someone suggested that each of its 28 different businesses assemble a team of lower- to mid-level managers, all under the age of 30, and give them the task of finding opportunities that their “older managers” had missed. The young teams returned with a number of fresh ideas, including several focused on how GE Capital could further capitalize on the Internet. New growth strategies come from new ideas. New ideas often come from new voices. Drawing on the collective strengths of the organization is what strategy formulation is all about. To meet the challenges brought on by growing domestic and global competition, business-to-business firms are increasingly recognizing the vital role of the marketing function in developing and implementing successful business strategies. Effective business strategies share many common characteristics, but at a minimum they are responsive to market needs, they exploit the special competencies of the organization, and they use valid assumptions about environmental trends and competitive behavior. Above all, they must offer a realistic basis for securing and sustaining a competitive advantage.2 This chapter examines the nature and critical importance of strategy development in the business marketing firm. First, the chapter highlights the special role of the marketing function in corporate strategy development, with a functionally integrated perspective of business marketing planning. Next, it identifies the sources of competitive advantage by exploring the key components of a business model and how they can be managed to secure distinctive strategic positioning. Finally, a framework is offered for converting strategy goals into a tightly integrated customer strategy. This discussion provides a foundation for exploring business marketing strategy on a global scale—the theme of the next chapter. Marketing’s Strategic Role Market-driven firms are centered on customers—they take an outside-in view of strategy and demonstrate an ability to sense market trends ahead of their competitors.3 Many firms—like Johnson & Johnson, Motorola, and Dow Chemical—have numerous divisions, product lines, products, and brands. Policies established at the corporate level provide the framework for strategy development in each business division to ensure survival and growth of the entire enterprise. In turn, corporate and divisional policies establish the boundaries within which individual product or market managers develop strategy. The Hierarchy of Strategies Three major levels of strategy dominate most large multiproduct organizations: (1) corporate strategy, (2) business-level strategy, and (3) functional strategy.4 1 Gary Hamel, “Bringing Silicon Valley Inside,” Harvard Business Review 77 (September–October 1999): pp. 78–79. See also Gary Hamel, “The Why, What, and How of Management Innovation,” Harvard Business Review 84 (February 2006): pp. 72–84. 2 Eric M. Olson, Stanley F. Slater, and G. Thomas M. Hult, “The Performance Implications of Fit among Business Strategy, Marketing Organization Structure, and Strategic Behavior,” Journal of Marketing 69 (July 2005): pp. 49–65. 3 For a comprehensive review, see Ahmet H. Kirca, Satish Jayachandran, and William O. Bearden, “Market Orientation: A Meta Analytic Review of Its Antecedents and Impact on Performance,” Journal of Marketing 69 (April 2005): pp. 24–41. 4 This discussion draws on Frederick E. Webster Jr., “The Changing Role of Marketing in the Corporation,” Journal of Marketing 56 (October 1992): pp. 1–17. Chapter 6 Business Marketing Planning: Strategic Perspectives 155 Corporate strategy defines the businesses in which a company competes, preferably in a manner that uses resources to convert distinctive competence into competitive advantage. Essential questions at this level include: What are our core competencies? What businesses are we in? What businesses should we be in? How should we allocate resources across these businesses to achieve our overall organizational goals and objectives? At this level of strategy, the role of marketing is to (1) assess market attractiveness and the competitive effectiveness of the firm, (2) promote a customer orientation to the various constituencies in management decision making, and (3) formulate the firm’s overall value proposition (as a reflection of its distinctive competencies, in terms reflecting customer needs) and to articulate it to the market and to the organization at large. According to Frederick Webster Jr., “At the corporate level, marketing managers have a critical role to play as advocates, for the customer and for a set of values and beliefs that put the customer first in the firm’s decision making.”5 Business-level strategy centers on how a firm competes in a given industry and positions itself against its competitors. The focus of competition is not between corporations; rather, it is between their individual business units. A strategic business unit (SBU ) is a single business or collection of businesses that has a distinct mission, a responsible manager, and its own competitors and that is relatively independent of other business units. The 3M Corporation has defined 40 strategic business units. Each develops a plan describing how it will manage its mix of products to secure a competitive advantage consistent with the level of investment and risk that management is willing to accept. An SBU could be one or more divisions of the industrial firm, a product line within one division, or, on occasion, a single product. Strategic business units may share resources such as a sales force with other business units to achieve economies of scale. An SBU may serve one or many product-market units. For each business unit in the corporate portfolio, the following essential questions must be answered: How can we compete most effectively for the product market the business unit serves? What distinctive skills can give the business unit a competitive advantage? Similarly, the former CEO at GE, Jack Welch, asks his operating executives to crisply answer the following questions6: • Describe the global competitive environment in which you operate. • In the last two years, what have your competitors done? • In the same period, what have you done to them in the marketplace? • How might they attack you in the future? • What are your plans to leapfrog them? The marketing function contributes to the planning process at this level by providing a detailed and complete analysis of customers and competitors and the firm’s distinctive skills and resources for competing in particular market segments. Functional strategy centers on how resources allocated to the various functional areas can be used most efficiently and effectively to support the business-level strategy. The primary focus of marketing strategy at this level is to allocate and coordinate 5 6 Ibid.; Webster, “The Changing Role of Marketing,” p. 11. Noel M. Tichy and Stratford Sherman, Control Your Destiny or Someone Else Will (New York: Doubleday, 1993), p. 26; see also Jack Welch and John A. Byrne, Jack: Straight from the Gut (New York: Warner Books, 2001). 156 Part IV Formulating Business Marketing Strategy marketing resources and activities to achieve the firm’s objective within a specific product market. Strategy Formulation and the Hierarchy7 The interplay among the three levels of the strategy hierarchy can be illustrated by examining the collective action perspective of strategy formulation. This approach applies to strategic decisions that (1) cut across functional areas, (2) involve issues related to the organization’s long-term objectives, or (3) involve allocating resources across business units or product markets. Included here are decisions about the direction of corporate strategy, the application of a core technology, or the choice of an alliance partner. Observe in Figure 6.1 that strategic decision processes often involve the active participation of several functional interest groups that hold markedly different beliefs about the appropriateness of particular strategies or corporate goals. Strategic decisions represent the outcome of a bargaining process among functional interest groups (including marketing), each of which may interpret the proposed strategy in an entirely different light. Turf Issues and Thought-World Views Two forces contribute to the conflict that often divides participants in the strategy formulation process. First, different meanings assigned to a proposed strategy are often motivated by deeper differences in what might be called “organizational subcultures.” Subcultures exist when one subunit shares different values, beliefs, and goals than another subunit, resulting in different thought-worlds.8 For example, marketing managers are concerned with market opportunities and competitors, whereas R&D managers value technical sophistication and innovation. Second, functional managers are likely to resist strategic changes that threaten their turf. To the extent that the subunit defines the individual’s identity and connotes prestige and power, the organizational member may be reluctant to see it altered by a strategic decision. Negotiated Outcomes Collective decisions emerge from negotiation and compromise among partisan participants. The differences in goals, thought-worlds, and self-interests across participants lead to conflicts about actions that should be taken. Choices must be negotiated with each interest group attempting to achieve its own ends. The ultimate outcomes of collective decisions tend to unfold incrementally and depend more on the partisan values and influence of the various interest groups than on rational analysis. A study of highly contested strategic decision in a Fortune 500 company illustrates the tension that may exist between marketing and R&D. Two marketing executives describe how the decision was ultimately resolved.9 According to the marketing manager: [Marketing] did an extremely effective job of stepping right in the middle of it and strangling it. . . . What has happened is by laying out the market unit 7 Gary L. Frankwick, James C. Ward, Michael D. Hutt, and Peter H. Reingen, “Evolving Patterns of Organizational Beliefs in the Formation of Marketing Strategy,” Journal of Marketing 58 (April 1994): pp. 96–110; see also Michael D. Hutt, Beth A. Walker, and Gary L. Frankwick, “Hurdle the Cross-Functional Barriers to Strategic Change,” Sloan Management Review 36 (Spring 1995): pp. 22–30. 8 See, for example, Christian Homburg, Ore Jensen, and Harley Krohmer, “Configurations of Marketing and Sales,” Journal of Marketing 72 (March 2008): pp. 123–154; and Christian Homburg and Ore Jensen, “The Thought Worlds of Marketing and Sales: Which Differences Make a Difference?” Journal of Marketing 71 (July 2007): pp. 124–141. 9 Frankwick, Ward, Hutt, and Reingen, “Evolving Patterns of Organizational Beliefs,” pp. 107–108. Chapter 6 Select Strategic Option and Negotiate Objectives Communicate Guidelines for Strategic Decision Negotiate and Establish Evaluate Strategic B U S I N E S S Preliminary Objectives Options F U N C T I O N Situation Analysis Negotiate and and Review of Current Strategy Develop Strategic Options OU T W S LD OR GH Communicate Strategy and Functional Objectives TH 157 A COLLECTIVE ACTION PERSPECTIVE OF THE STRATEGY FORMULATION PROCESS FIGURE 6.1 C O R P O R A T E Business Marketing Planning: Strategic Perspectives Marketing R&D Manufacturing Other Interpret Meaning of Strategic Change to Functional Interest Group Integrate Functional Plans Negotiate and Develop Functional Plans TURF SOURCE: Gary L. Frankwick, James C. Ward, Michael D. Hutt, and Peter H. Reingen, “Evolving Patterns of Organizational Beliefs in the Formation of Strategy,” Journal of Marketing 58 (April 1994): p. 98. Reprinted with permission by the American Marketing Association. concerns and again, refocusing on the fact that we are market-based, basically what Marketing did was force the R&D team into submission where they no longer have the autonomy they once had to go about making decisions—they now get input. And whether it’s formal or informal, they definitely get the buy-in of marketing before they move forward on what they’re doing now. According to the vice president of marketing: Before I felt it was technology driving the process. Now I feel that technology is partnering with the marketplace. And the reason I feel that way is because we have [marketing people] in place that are working closely with how the technology develops. 158 Part IV Formulating Business Marketing Strategy INSIDE BUSINESS MARKETING From Bullet-Point Plans to Strategic Stories at 3M After reviewing countless business plans over several years, Gordon Shaw, executive director of planning at 3M, concluded that the firm’s business plans failed to reflect deep thought or to inspire commitment and active support. He suspected that the traditional, bullet-list format of the plans was a major part of the problem. Bullet lists are too generic and fail to convey how the business will win in a particular market. To remedy the problem, he turned to strategic narratives—planning through storytelling. Like a good story, a good strategic plan “defines relationships, cause and effect, and a priority among items—and those elements are likely to be remembered as a complex whole.” In using the approach, a strategist at 3M first sets the stage by defining the current competitive, market, and company situation in an insightful and coherent manner. Next, the planner must introduce the dramatic conflict—the main challenges or critical issues that provide obstacles to success. Finally, the story must reach resolution in a satisfying and compelling fashion. Here a logical and concise argument is provided concerning the specific actions the company can take to overcome the obstacles and win. Narrative plans create a rich picture of strategy, bring critical assumptions to the surface, and provide a central message that can motivate and mobilize employees throughout the organization. SOURCE: Gordon Shaw, Robert Brown, and Philip Bromley, “Strategic Stories: How 3M Is Rewriting Business Planning,” Harvard Business Review 76 (May/June 1998): pp. 41–50. See also, David J. Collins and Michael G. Rukstad, “Can You Say What Your Strategy Is?” Harvard Business Review 86 (April 2008): pp. 82–89. Implications for Marketing Managers In advocating a strategic course, marketing managers must be sensitive to the likely response it may arouse in other interest groups. To build pockets of commitment and trust, managers should develop and use a communication network that includes organizational members who have a major stake in the decision. Marketing managers can use these personal networks to understand the interests of other stakeholders, communicate their own interests clearly and sensitively, and thus diffuse the anxiety of others about threats to their turf. Functionally Integrated Planning: The Marketing Strategy Center10 Rather than operating in isolation from other functional areas, the successful business marketing manager is an integrator—one who understands the capabilities of manufacturing, R&D, and customer service and who capitalizes on their strengths in developing marketing strategies that are responsive to customer needs. Marketing managers also assume a central role in strategy implementation.11 Recent research indicates that in companies found to be strong on strategy execution, over 70 percent of employees affirm that they have a clear idea of the decisions and actions for which they are responsible; that figure drops to 32 percent in organizations weak on execution.12 10 Michael D. Hutt and Thomas W. Speh, “The Marketing Strategy Center: Diagnosing the Industrial Marketer’s Interdisciplinary Role,” Journal of Marketing 48 (Fall 1984): pp. 53–61; see also Jeen-Su Lim and David A. Reid, “Vital CrossFunctional Linkages with Marketing,” Industrial Marketing Management 22 (February 1993): pp. 159–165. 11 Charles H. Noble and Michael P. Mokwa, “Implementing Marketing Strategies: Developing and Testing a Managerial Theory,” Journal of Marketing, 63 (October 1999): pp. 57–73. 12Gary L. Neilson, Karla L. Martin, and Elizabeth Powers, “The Secrets to Successful Strategy Execution,” Harvard Business Review 86 (June 2008): p. 63. Chapter 6 Business Marketing Planning: Strategic Perspectives 159 B2B TOP PERFORMERS Cross-Functional Relationships: Effective Managers Deliver on Promises Ask an R&D manager to identify a colleague from marketing who is particularly effective at getting things done and he or she readily offers a name and a memorable episode to justify the selection. To explore the characteristics of high-performing crossfunctional managers, detailed accounts of effective and ineffective interactions were gathered from managers at a Fortune 100 high-technology firm. Interestingly, the top-of-mind characteristics that colleagues emphasize when describing high performers are soft skills like openness rather than hard skills like technical proficiency or marketing savvy. Here’s a profile: • High-performing managers are revered by their colleagues for their responsiveness. Remembering effective cross-functional episodes, colleagues describe high performers as “timely,” “prompt,” and “responsive” (for example, “When I need critical information, I turn to him and he gets right back to me”). • Rather than a “functional mindset,” high performers demonstrate perspective-taking skills— the ability to anticipate and understand the perspectives and priorities of managers from other units (for example, “He’s a superb marketing strategist but he also recognizes the special technical issues that we’ve been working through to get this product launched on schedule”). • When colleagues describe the communication style of their high-performing cross-functional counterparts, they focus on three consistent themes: openness, frequency, and quality. Interactions with high performers are described as “candid,” “unencumbered,” and characterized by a “free flow of thoughts and suggestions.” Such high-quality interactions clarify goals and responsibilities. By “delivering on their promises,” effective managers develop a web of close relationships across functions. “He has really good personal relationships with a lot of people and he has a network—he really understands the mechanisms that you have to use to get things done.” SOURCE: Michael D. Hutt, Beth A. Walker, Edward U. Bond III, and Matthew Meuter, “Diagnosing Marketing Managers’ Effective and Ineffective Cross-Functional Interactions,” working paper, Tempe, Ariz.: Arizona State University, 2005. See also Edward U. Bond III, Beth A. Walker, Michael D. Hutt, and Peter H. Reingen, “Reputational Effectiveness in CrossFunctional Working Relationships,” Journal of Product Innovation Management 21 ( January 2004): pp. 44–60. Responsibility charting is an approach that can classify decision-making roles and highlight the multifunctional nature of business marketing decision making. Table 6.1 provides the structure of a responsibility chart. The decision areas (rows) in the matrix might, for example, relate to a planned product-line expansion. The various functional areas that may assume particular roles in this decision process head the matrix columns. The following list defines the alternative roles that participants can assume in the decision-making process.13 1. Responsible (R): The manager takes initiative for analyzing the situation, developing alternatives, and assuring consultation with others and then makes the initial recommendation. Upon approval of decision, the role ends. 2. Approve (A): The manager accepts or vetoes a decision before it is implemented or chooses from alternatives developed by the participants assuming a “responsible” role. 13 Joseph E. McCann and Thomas N. Gilmore, “Diagnosing Organizational Decision Making through Responsibility Charting,” Sloan Management Review 25 (Winter 1983): pp. 3–15. 160 Part IV Formulating Business Marketing Strategy 3. Consult (C): The manager is consulted or asked for substantive input before the decision is approved but does not possess veto power. 4. Implement (M): The manager is accountable for implementing the decision, including notifying other relevant participants about the decision. 5. Inform (I): Although not necessarily consulted before the decision is approved, the manager is informed of the decision once it is made. Representatives of a particular functional area may, of course, assume more than one role in the decision-making process. The technical service manager may be consulted during the new-product-development process and may also be held accountable for implementing service-support strategy. Likewise, the marketing manager may be responsible for and approve many of the decisions related to the product-line expansion. For other actions, several decision makers may participate. To illustrate, the business unit manager, after consulting R&D, may approve (or veto) a decision for which the marketing manager is responsible. The members of the organization involved in the business marketing decision-making process constitute the marketing strategy center. The composition or functional area representation of the strategy center evolves during the marketing strategy development process, varies from firm to firm, and varies from one situation to another. Likewise, the composition of the marketing strategy center is not strictly prescribed by the organizational chart. The needs of a particular strategy situation, especially the information requirements, significantly influence the composition of the strategy center. Thus, the marketing strategy center shares certain parallels with the buying center (see Chapter 3). Managing Strategic Interdependencies A central challenge for the business marketer in the strategy center is to minimize interdepartmental conflict while fostering shared appreciation of the interdependencies with other functional units. Individual strategy center participants are motivated by both personal and organizational goals. They interpret company objectives in relation to their level in the hierarchy and the department they represent. Various functional units operate under unique reward systems and reflect unique orientations or thought-worlds. For example, marketing managers are evaluated on the basis of sales, profits, or market share; production managers on the basis of manufacturing efficiency and cost-effectiveness. In turn, R&D managers may be oriented toward long-term objectives; customer service managers may emphasize more immediate ones. Strategic plans emerge out of a bargaining process among functional areas. Managing conflict, promoting cooperation, and developing coordinated strategies are all fundamental to the business marketer’s interdisciplinary role. By understanding the concerns and orientations of personnel from other functional areas, the business marketing manager is better equipped to forge effective cross-unit working relationships. The Components of a Business Model14 For a strategy to succeed, individuals must understand and share a common definition of a firm’s existing business concept. For example, ask any employee at Dell and they 14 Except where noted, this discussion is based on Gary Hamel, Leading the Revolution (Boston: Harvard Business School Press, 2000), pp. 70–94. Chapter 6 TABLE 6.1 Business Marketing Planning: Strategic Perspectives 161 INTERFUNCTIONAL INVOLVEMENT IN MARKETING DECISION MAKING: AN ILLUSTRATIVE RESPONSIBILITY CHART Organizational Function Decision Area Marketing Manufacturing R&D Logistics Technical Service Strategic Business Unit Manager Corporate Level Planner PRODUCT Design specifications Performance characteristics Reliability PRICE List price Discount structure TECHNICAL SERVICE SUPPORT Customer training Repair LOGISTICS Inventory level Customer service level SALES FORCE Training ADVERTISING Message development CHANNEL Selection NOTE: Decision role vocabulary: R 5 responsible; A 5 approve; C 5 consult; M 5 implement; I 5 inform; X 5 no role in decision. 162 Part IV Formulating Business Marketing Strategy COMPONENTS OF A BUSINESS MODEL FIGURE 6.2 Configuration Customer Benefits Company Boundaries Customer Interface Core Strategy Strategic Resources Value Network Fullfillment & Support Information & Insight Relationship Dynamics Pricing Structure Business Mission Product/Market Scope Basis for Differentiation Core Competencies Strategic Assets Core Processes Suppliers Partners Coalitions SOURCE: Reprinted by permission of Harvard Business Review. From “Customer Benefits, Configuration and Boundaries” in Leading the Revolution by Gary Hamel, p. 96. Copyright © 2000 by the Harvard Business School Publishing Corporation; all rights reserved. will tell you about the “Dell model” that sets them apart from competitors. A business concept or model consists of four major components (Figure 6.2): • Customer Interface • Core Strategy • Strategic Resources • Value Network The major components of the business concept are tied together by three important “bridge” elements: customer benefits, configuration, and company boundaries. Customer Interface Customer benefits provide the bridge between the core strategy and the customer interface. Customer benefits link the core strategy directly to the needs of customers. The customer interface includes four elements: 1. Fulfillment and support refers to the channels a business marketing firm uses to reach customers and the level of service support it provides. 2. Information and insight refers to the knowledge captured from customers and the degree to which this information is used to provide enhanced value to the customer. 3. Relationship dynamics refers to the nature of the interaction between the firm and its customers (for example, the proportion of relational versus transactional customers; see Chapter 4). Key question: What steps can be taken to raise the hurdle for competitors by exceeding customer expectations or strengthening the customer’s sense of affiliation with the firm? 4. Pricing structure. A business concept may offer several pricing choices. For example, a firm can bundle products and services or price them on a menu basis. Chapter 6 Business Marketing Planning: Strategic Perspectives 163 For example, when airlines buy a Boeing 777, which is equipped with jet engines produced by GE, they pay GE a fee for each flight hour in line with a fixedpriced maintenance agreement. So, rather than products, GE is selling “power by the hour.” Core Strategy The core strategy determines how the firm chooses to compete. From Figure 6.2, observe that three elements are involved in setting a core strategy: 1. The business mission describes the overall objectives of the strategy, sets a course and direction, and defines a set of performance criteria that are used to measure progress. The business mission must be broad enough to allow for business concept innovation, and it should be distinguished from the mission of competitors in the industry. For example, by focusing its mission on copiers and copying, Xerox allowed Hewlett-Packard to build a dominant lead in the printer business. 2. Product /market scope defines where the firm competes. The product markets that constitute the domain of a business can be defined by customer benefits, technologies, customer segments, and channels of distribution.15 Strategists might consider this question: Are particular customer segments being overlooked by competitors or customers who might welcome a new productservice solution? 3. Basis for differentiation captures the essence of how a firm competes differently than its rivals. George Day and Robin Wensley explain: A business is differentiated when some value-adding activities are performed in a way that leads to perceived superiority along dimensions that are valued by customers. For these activities to be profitable, the customer must be willing to pay a premium for the benefits and the premium must exceed the added costs of superior performance.16 There are many ways for a firm to differentiate products and services: • Provide superior service or technical assistance competence through speed, responsiveness to complex orders, or ability to solve special customer problems. • Provide superior quality that reduces customer costs or improves their performance. • Offer innovative product features that use new technologies. 15 George S. Day, Strategic Market Planning: The Pursuit of Competitive Advantage (St. Paul, MN: West Publishing, 1984). 16 George S. Day and Robin Wensley, “Assessing Advantage: A Framework for Diagnosing Competitive Superiority,” Journal of Marketing 52 (April 1988): pp. 3–4. See also Douglas W. Vorhies and Neil A. Morgan, “Benchmarking Marketing Capabilities for Sustainable Competitive Advantage,” Journal of Marketing 69 ( January 2005): pp. 80–94. 164 Part IV Formulating Business Marketing Strategy Strategic Resources A business marketing firm gains a competitive advantage through its superior skills and resources. The firm’s strategic resources include core competencies, strategic assets, and core processes. 1. Core competencies are the set of skills, systems, and technologies a company uses to create uniquely high value for customers.17 For example, Dell uses its direct-distribution competencies to sell a host of new products to corporate customers, including switches, servers, storage, and a range of peripheral products.18 Concerning core competencies, the guiding questions for the strategist are: What important benefits do our competencies provide to customers? What do we know or do especially well that is valuable to customers and is transferable to new market opportunities? 2. Strategic assets are the more tangible requirements for advantage that enable a firm to exercise its capabilities. Included are brands, customer data, distribution coverage, patents, and other resources that are both rare and valuable. Attention centers on this question: Can we use these strategic assets in a different way to provide new levels of value to existing or prospective customers? 3. Core processes are the methodologies and routines companies use to transform competencies, assets, and other inputs into value for customers. For example, drug discovery is a core process at Merck, and delivery fulfillment is a core process at FedEx. Here the strategist considers these questions: Which processes are most competitively unique and create the most customer value? Could we use our process expertise effectively to enter other markets? From Figure 6.2, note that a configuration component links strategic resources to the core strategy. “Configuration refers to the unique way in which competencies, assets, and processes are interrelated in support of a particular strategy.”19 For example, Honda manages key activities in the new-product-development process differently than its rivals. The Value Network The final component of a business concept is the value network that complements and further enriches the firm’s research base. Included here are suppliers, strategic alliance partners, and coalitions. To illustrate, nimble competitors like Cisco and General Electric demonstrate special skills in forging relationships with suppliers and alliance partners. Concerning the value network, the guiding question for the strategist is: What market opportunities might become available to us “if we could ‘borrow’ the assets and competencies of other companies and marry them with our own?”20 17 James Brian Quinn, “Strategic Outsourcing: Leveraging Knowledge Capabilities,” Sloan Management Review 40 (Summer 1999): pp. 9–21. 18 Andy Serwer, “Dell Does Domination,” Fortune, January 21, 2002, pp. 70–75. 19 Hamel, Leading the Revolution, p. 78. 20 Ibid., p. 90. Chapter 6 FIGURE 6.3 Business Marketing Planning: Strategic Perspectives 165 THE PRINCIPLES OF STRATEGIC POSITIONING Right Goal: Profitability Unique Value proposition Strategic Positioning Distinctive Value Chain Trade-Offs Fit: Mutually-Reinforcing Activities Continuity of Direction SOURCE: Adapted from Michael E. Porter, “What Is Strategy?” Harvard Business Review 74 (November–December 1996): pp. 61–78. Strategic Positioning21 Competitive strategy, at the core, is about being different, choosing to compete in a distinctive way. A business model should reveal the way in which a firm is deliberately emphasizing a different set of activities in order to deliver a unique mix of customer value. Michael Porter asserts that six fundamental principles provide a company with the foundation for establishing and maintaining a distinctive strategic positioning (see Figure 6.3). • Center on the right goal—superior long-term return on investment rather than performance goals defined in terms of sales volume or market share leadership. • Deliver a customer value proposition, or set of benefits, that differs from those of rivals. (For example, Southwest Airlines delivers low-cost, convenient service to customers—particular benefits that full-service rivals cannot match.) • Create a distinctive value chain by performing different activities than rivals or performing similar activities in different ways. (For example, by streamlining the passenger boarding process, Southwest achieves faster turnaround at the gate and can provide more frequent departures with fewer planes.) 21 This section is based on Michael E. Porter, “What Is Strategy?” Harvard Business Review 74 (November–December 1996): pp. 61–78. 166 Part IV Formulating Business Marketing Strategy • Accept trade-offs and recognize that a company must forgo some product features or services to remain truly distinctive in others. (For example, Continental Airlines introduced Continental Lite to compete directly against Southwest. By trying to be low cost on some routes and full service on others, Continental lost several hundred million dollars before grounding Continental Lite.) • Emphasize the way in which all the elements of the strategy fit and reinforce one another. (For example, from its standardized fleet of Boeing 737 aircraft to its well-trained ground crews that speed flight turnaround, and its strict limits on the type and length of routes, Southwest’s activities complement and reinforce one another, creating a whole system of competing that locks out imitators.) • Build strong customer relationships and develop unique skills by defining a distinctive value proposition that provides continuity of direction. (For example, Southwest continues to pursue its disciplined strategic agenda.) Michael Porter observes: Having a strategy is a matter of discipline. It requires a strong focus on profitability rather than just growth, an ability to define a unique value proposition, and a willingness to make tough trade-offs in choosing what not to do. . . . It involves the configuration of a tailored value chain—the series of activities required to produce and deliver a product or service—that enables a company to offer unique value.22 Let’s examine how a business-to-business firm has used these principles to establish and maintain a distinctive strategic positioning. Strategic Positioning Illustrated 23 Paccar operates in the fiercely competitive heavy-duty truck industry, designing and manufacturing trucks under the Kenworth and Peterbilt brand names. The firm, headquartered in Bellevue, Washington, commands 20 percent of the North American heavy truck market and derives approximately half of its revenues and profits from outside the United States. A Unique Focus Rather than centering on large-fleet buyers or large leasing companies, Paccar has chosen to focus on one group of customers—drivers who own their own trucks and contract directly with shippers or serve as contractors to larger trucking companies. Paccar provides an array of specialized services that specifically address the needs of owner-operators: luxurious sleeper cabins, noise-insulated cabins, and sleek interior and exterior options (numbering in the thousands) that prospective buyers can select to put their personal signatures on their trucks. Paccar delivers its products and services to customers through an extensive dealer network of nearly 1,800 locations worldwide. 22Michael E. Porter, “Strategy and the Internet,” Harvard Business Review 79 (March 2001): p. 72. 23This illustration is based on Michael E. Porter, “The Five Competitive Forces that Shape Strategy,” Harvard Business Review 86 ( January 2008): p. 89. Chapter 6 Business Marketing Planning: Strategic Perspectives 167 Distinctive Value Proposition Built to order, these customized trucks are delivered to customers in six to eight weeks and incorporate features and value-added services that are embraced by owner-operators. Paccar’s trucks feature an aerodynamic design that reduces fuel consumption and they maintain resale value better than the trucks offered by rivals. To reduce out-of-service time, Paccar offers a comprehensive roadside assistance program and an information-technology-supported system for expediting and delivering spare parts. According to Michael Porter, “Customers pay Paccar a 10 percent premium, and its Kenworth and Peterbilt brands are considered status symbols at truck stops.”24 Moreover, Paccar has received recognition for consistently leading the heavy-duty truck market in quality, innovation, and customer satisfaction.25 By configuring its activities on new product development, manufacturing, and service support differently from rivals, and by tailoring these activities to its customer value proposition, Paccar has achieved an enviable record of financial performance: 68 straight years of profitability, averaging a long-run return on equity above 20 percent. Building the Strategy Plan By finding an intricate match between strategy and operations, strategic positioning depends on doing many things well—not just a few. But yet, most companies’ underperformance is caused by breakdowns between strategy and operations. Robert S. Kaplan and David P. Norton contend that successful strategy execution involves two basic rules: “understand the management cycle that links strategy and operations, and know what tools to apply at each stage of the cycle.”26 To that end, they propose that companies develop a management system to plan, coordinate, and monitor the links between strategy and operations. This management system represents “the integrated set of processes and tools that a company uses to develop its strategy, translate it into operational actions, and monitor and improve the effectiveness of both.”27 (See Figure 6.4.) Observe that the management system involves five stages, beginning with strategy development (Stage 1) and then moving on to the crucial stage of translating the strategy (Stage 2) into objectives and measures that can be clearly communicated to all functional areas and employees. We will give special attention to two tools: (1) the balanced scorecard that provides managers with a comprehensive system for converting a company’s vision and strategy into a tightly connected set of performance measures; and (2) the strategy map—a tool for visualizing a firm’s strategy as a chain of cause-and-effect relationships among strategic objectives. These tools and processes assume a central role in designing key processes (Stage 3), monitoring performance (Stage 4), and adapting the strategy (Stage 5). 24Ibid. 25“Kenworth Wins J.D. Power Awards,” August 27, 2007, accessed at http://www.paccar.com/company/jdpower on July 11, 2008. 26Robert S. Kaplan and David P. Norton, “Mastering the Management System,” Harvard Business Review 86 (January 2008): p. 63. 27Ibid., p. 64. 168 Part IV Formulating Business Marketing Strategy FIGURE 6.4 THE MANAGEMENT SYSTEM: LINKING STRATEGY AND OPERATIONS Develop the Strategy Stage 1 Define Mission, Vision, and Values Conduct Strategic Analysis Translate the Strategy Stage 2 Formulate Strategy Test and Adapt the Strategy Define Strategic Objectives and themes Stage 5 Examine Emerging Strategies Select measures and targets Select Strategic initiatives Plan Operations Stage 3 Conduct Profitablity Analysis Monitor and Learn Stage 4 Improve Key Processes Develop Sales Plan Prepare Budgets Hold Strategy Reviews Hold Operational Reviews Execute Processes and Initiatives SOURCE: Adapted with modifications from Robert S. Kaplan and David P. Norton, “Mastering the Management System,” Harvard Business Review 86 ( January 2008): p. 65. The Balanced Scorecard 28 Measurement is a central element in the strategy process. The balanced scorecard combines financial measures of past performance with measures of the drivers of performance. Observe in Figure 6.5 that the scorecard examines the performance of a business unit from four perspectives: (1) financial, (2) customer, (3) internal business processes, and (4) learning and growth. The architects of the approach, Robert Kaplan and David Norton, emphasize that “the scorecard should tell the story of the strategy, starting with the long-run financial objectives, and then linking them to the sequence of actions that must be taken with financial processes, customers, and finally employees and systems to deliver the desired long-run economic performance.”29 Financial Perspective Financial performance measures allow business marketing managers to monitor the degree to which the firm’s strategy, implementation, and execution are increasing profits. 28 Except where noted, this discussion is based on Robert S. Kaplan and David P. Norton, Strategy Maps: Converting Intangible Assets into Tangible Outcomes (Boston: Harvard Business School Publishing Corporation, 2004). See also Robert S. Kaplan and David P. Norton, The Balanced Scorecard: Translating Strategy into Action (Boston: Harvard Business School Press, 1996), chaps. 1–3. 29 Kaplan and Norton, The Balanced Scorecard, p. 47. Chapter 6 Business Marketing Planning: Strategic Perspectives 169 THE BALANCED SCORECARD: A FRAMEWORK TO TRANSLATE A STRATEGY INTO OPERATIONAL TERMS FIGURE 6.5 Financial Perspective Cause-and-Effect Relationships Long-Term Shareholder Value Productivity Revenue Growth Defines the chain of logic by which intangible assets will be transformed to tangible value. Customer Perspective Product/Service Attributes Price Quality Time Function Relationship Image Partnership Brand Customer Value Proposition Clarifies the conditions that will create value for the customer. Internal Process Perspective Manage Operations Manage Customers Manage Regulatory and Social Processes Manage Innovation Learning and Growth Perspective Human Capital + Information Capital Value-Creating Processes Defines the processes that will transform intangible assets into customer and financial outcomes. Clustering of Assets and Activities + Organization Capital Defines the intangible assets that must be aligned and integrated to create the value. SOURCE: Reprinted by permission of Harvard Business Review. From “Balanced Scorecard Framework” by Robert S. Kaplan in Strategy Maps, p. 31. Copyright © 2004 by the Harvard Business School Publishing Corporation; all rights reserved. Measures such as return on investment, revenue growth, shareholder value, profitability, and cost per unit are among the performance measures that show whether the firm’s strategy is succeeding or failing. Companies emphasize two basic levers in developing a financial strategy: revenue growth and productivity.30 The revenue-growth strategy centers on securing sales from new markets and new products or strengthening and expanding relationships with existing customers. The productivity strategy can also take two forms: improve the company’s cost structure by reducing expenses and/or use assets more efficiently by decreasing the working and fixed capital needed to support a given level of output. The balanced scorecard seeks to match financial objectives to a business unit’s growth and life cycle stages. Three stages of a business are isolated and linked to appropriate financial objectives: 1. Growth: Business units that have products and services with significant growth potential and that must commit considerable resources (for example, production facilities and distribution networks) to capitalize on the market opportunity. 30 Robert S. Kaplan and David P. Norton, “Having Trouble with Your Strategy? Then Map It,” Harvard Business Review 78 (September–October 2000): pp. 167–176. 170 Part IV Formulating Business Marketing Strategy Financial Objectives: Sales growth rate by segment; percentage of revenue from new product, services, and customers. 2. Sustain: Business units, likely representing the majority of businesses within a firm, that expect to maintain or to perhaps moderately increase market share from year to year. Financial Objectives: Share of target customers and accounts; customer and product-line profitability. 3. Harvest: Mature business units that warrant only enough investment to maintain production equipment and capabilities. Financial Objectives: Payback; customer and product-line profitability. Customer Perspective In the customer component of the balanced scorecard, the business unit identifies the market segments it will target (see Chapter 5). Those segments supply the revenue stream that support critical financial objectives. Marketing managers must also identify the value proposition—how the firm proposes to deliver competitively superior and sustainable value to the target customers and market segments. The central element of any business strategy is the value proposition that describes a company’s unique product and service attributes, customer relationship management practices, and corporate reputation. Importantly, the value proposition should clearly communicate to targeted customers what the company expects to do better and differently than its competitors. Key Value Propositions and Customer Strategies Business-to-business firms typically choose among four forms of differentiation in developing a value proposition31: • Low total cost—customers are offered attractive prices, excellent and consistent quality, ease of purchase, and responsive service (for example, Dell, Inc.). • Product innovation and leadership—customers receive products that expand existing performance boundaries through new features and functions (for example, Intel and Sony). • Complete customer solutions—customers feel that the company understands them and can provide customized products and services tailored to their unique requirements (for example, IBM). • Lock-in—customers purchase a widely used proprietary product or service from the firm and incur high switching costs (for example, Microsoft’s operating system, Cisco’s infrastructure products, or Google’s search engine). For the chosen strategy, Table 6.2 presents the core customer outcome measures used to monitor performance in each target segment. The customer perspective complements traditional market share analysis by tracking customer acquisition, customer retention, customer satisfaction, and customer profitability. 31 Kaplan and Norton, Strategy Maps, pp. 322–344. Chapter 6 TABLE 6.2 Business Marketing Planning: Strategic Perspectives 171 THE CUSTOMER PERSPECTIVE—CORE MEASURES Market Share Customer Acquisition Customer Retention Customer Satisfaction Customer Profitability Represents the proportion of business in a given market (in terms of number of customers, dollars spent, or unit volume sold) that a business unit sells. Tracks, in absolute or relative terms, the rate at which a business unit attracts or wins new customers or business. Tracks, in absolute or relative terms, the rate at which a business unit retains customers. Matches the satisfaction level of customers on specific performance criteria such as quality, service, or on-time delivery reliability. Assesses the net profit of a customer, or segment, after deducting the unique expenses required to support that customer or segment. SOURCE: Adapted from Robert S. Kaplan and David P. Norton, The Balanced Scorecard: Translating Strategy into Action (Boston: Harvard Business School Press, 1996): p. 68. Internal Business Process Perspective To develop the value proposition that will reach and satisfy targeted customer segments and to achieve the desired financial objectives, critical internal business processes must be developed and continually enriched. Internal business processes support two crucial elements of a company’s strategy: (1) they create and deliver the value proposition for customers and (2) they improve processes and reduce costs, enriching the productivity component in the financial perspective. Among the processes vital to the creation of customer value are 1. Operations Management Processes, 2. Customer Management Processes, 3. Innovation Management Processes. Strategic Alignment Robert S. Kaplan and David P. Norton emphasize that “value is created through internal business processes.”32 Table 6.3 shows how key internal processes can be aligned to support the firm’s customer strategy or differentiating-value proposition. First, observe that the relative emphasis (see shaded areas) given to a particular process vary by strategy. For example, a firm that actively pursues a product-leadership strategy highlights innovation-management processes, whereas a company adopting a lowtotal-cost strategy assigns priority to operations-management processes. Second, although the level of emphasis might vary, note how the various processes work together to reinforce the value proposition. For example, a low-total-cost strategy can be reinforced by an innovation-management process that uncovers process improvements and a customer relationship management process that delivers superb postsales support. From our discussion of strategic positioning, recall that it is much harder for a rival to match a set of interlocked processes than it is to replicate a single process. Michael Porter observes: Strategic fit among many activities is fundamental not only to competitive advantage but also to the sustainability of that advantage. . . . Positions built on systems of activities are far more sustainable than those built on individual activities.33 32 Ibid., p. 43. 33 Michael E. Porter, “What Is Strategy?” Harvard Business Review 74 (November–December 1996): p. 73. 172 Part IV Formulating Business Marketing Strategy ALIGNING INTERNAL BUSINESS PROCESSES TO THE CUSTOMER STRATEGY TABLE 6.3 Customer Strategy The Focus of Internal Business Processes Operations Management Customer Relationship Management Innovation Management Low-Total-Cost Strategy Highly Efficient Operating Processes Efficient, Timely Distribution Ease of Access for Customers; Superb Postsales Service Seek Process Innovations Gain Scale Economies Product Leadership Strategy Flexible Manufacturing Processes Rapid Introduction of New Products Capture Customer Ideas for New Offering Educate Customers about Complex New Products/ Services Disciplined, HighPerformance Product Development First-to-Market Complete Customer Solutions Strategy Deliver Broad Product / Service Line Create Network of Suppliers for Extended Product/Service Capabilities Create Customized Solutions for Customers Build Strong Customer Relationships Develop Customer Knowledge Identify New Opportunities to Serve Customers Anticipate Future Customer Needs Lock-in Strategies Provide Capacity for Proprietary Product / Service Reliable Access and Ease of Use Create Awareness Influence Switching Costs of Existing and Potential Customers Develop and Enhance Proprietary Product Increase Breadth / Applications of Standard SOURCE: Reprinted by permission of Harvard Business Review. From “Customer Objectives for Different Value Propositions” by Robert S. Kaplan in Strategy Maps, p. 41. Copyright © 2004 by the Harvard Business School Publishing Corporation; all rights reserved. Learning and Growth The fourth component of the balanced scorecard, learning and growth, highlights how the firm’s intangible assets must be aligned to its strategy to achieve long-term goals. Intangible assets represent “the capabilities of the company’s employees to satisfy customer needs.”34 The three principal drivers of organizational learning and growth are 1. human capital—the availability of employees who have the skills, talent, and know-how to perform activities required by the strategy; 2. information capital—the availability of information systems, applications, and information-technology infrastructure to support the strategy; 3. organization capital—the culture (for example, values), leadership, employee incentives, and teamwork to mobilize the organization and execute the strategy. 34 Thomas A. Stewart, Intellectual Capital: The New Wealth of Organizations (New York: Doubleday, 1998), p. 67, cited in Kaplan and Norton, Strategy Maps, pp. 202–203. Chapter 6 Business Marketing Planning: Strategic Perspectives 173 Strategic Alignment To create value and advance performance, the intangible assets of the firm must be aligned with the strategy. For example, consider a company that plans to invest in staff training and has two choices—a training program on total quality management (TQM) or a training initiative on customer relationship management (CRM). A company like Dell, which pursues a low-total-cost strategy, might derive higher value from TQM training, whereas IBM’s consulting unit, which pursues a total customer solution strategy, would benefit more from CRM training. Unfortunately, research suggests that two-thirds of organizations fail to create strong alignment between their strategies and their human resources and information technology programs.35 Measuring Strategic Readiness Senior management must ensure that the firm’s human resources and information technology systems are aligned with the chosen strategy. To achieve desired performance goals in the other areas of the scorecard, key objectives must be achieved on measures of employee satisfaction, retention, and productivity. Likewise, front-line employees, like sales or technical service representatives, must have ready access to timely and accurate information. However, skilled employees who are supported by a carefully designed information system will not contribute to organizational goals if they are not motivated or empowered to do so. Many firms, such as FedEx and 3M, have demonstrated the vital role of motivated and empowered employees in securing a strong customer franchise. Now that each of the components of the balanced scorecard have been defined, let’s explore a clever tool that can be used to communicate the desired strategy path to all employees while detailing the processes that will be used to implement the strategy. Strategy Map To provide a visual representation of the cause-and-effect relationships among the components of the balanced scorecard, Kaplan and Norton developed what they call a strategy map. They say that a strategy must provide a clear portrait that reveals how a firm will achieve its desired goals and deliver on its promises to employees, customers, and shareholders. “A strategy map enables an organization to describe and illustrate, in clear and general language, its objectives, initiatives, and targets; the measures used to assess performance (such as market share and customer surveys); and the linkages that are the foundation for strategic direction.”36 Key Strategy Principles Figure 6.6 shows the strategy map template for a firm pursuing a product-leadership strategy. We can use this illustration to review and reinforce the key principles that underlie a strategy map: • Companies emphasize two performance levels in developing a financial strategy—a productivity strategy and a revenue-growth strategy. • Strategy involves choosing and developing a differentiated customer value proposition. Note the value proposition for product leadership: “Products and services that expand existing performance boundaries into the highly desirable.” Recall that the other value propositions and customer strategies include low total cost, complete customer solutions, and system lock-in. 35 36 Kaplan and Norton, Strategy Maps, p. 13. Kaplan and Norton, “Having Trouble with Your Strategy?” p. 170. 174 Part IV Formulating Business Marketing Strategy FIGURE 6.6 STRATEGY MAP TEMPLATE: PRODUCT LEADERSHIP Long-Term Shareholder Value Financial Perspective Revenue Growth Strategy Productivity Strategy Revenues from New Products Manage Total Life-Cycle Product Costs Gross Margins: New Products ”Products and Services That Expand Existing Performance Boundaries into the Highly Desirable“ Customer Perspective High-Performance Products: Smaller, Faster, Lighter, Cooler, More Accurate, More Storage, Brighter… First to market Operations Management Internal Perspective Flexible Robust Processes Supply Capacity for Rapid Growth Rapid Introduction of New Products In-line Experimentation and Improvement ” New Customer Segments Customer Management Innovation Regulatory and Social Educate Customers about Complex New Products/Services Disciplined, High-Performance Product Development Minimize Product Liability and Environmental Impact Capture Customer Ideas for New Products/Services Product Development Time: From Idea to Market Contribute to Communities “Find, Motivate, Grow, and Retain the Best Talent” A Capable, Motivated and Technologically Enabled Workforce Learning and Growth Perspective Human Capital Deep Functional Expertise Creative, Versatile Employees: Crossfunctional Teamwork Information Capital Virtual Product Prototyping and Simulation Computer-Aided Design and Manufacturing (CAD/CAM) Organization Capital Creativity, Innovation SOURCE: Reprinted by permission of Harvard Business Review. From “Project Leadership” by Robert S. Kaplan in Strategy Maps, p. 326. Copyright © 2004 by the Harvard Business School Publishing Corporation; all rights reserved. • Value is created through internal business processes. The financial and customer perspectives in the balanced scorecard and strategy map describe the performance outcomes the firm seeks, such as increases in shareholder value through revenue growth and productivity improvements, as well as enhanced performance outcomes from customer acquisition, retention, loyalty, and growth. • Strategy involves identifying and aligning the critical few processes that are most important for creating and delivering the customer value proposition. For a product-leadership Chapter 6 Business Marketing Planning: Strategic Perspectives 175 strategy, observe how each of the internal business processes directly supports the customer value proposition—product leadership. • Value is enhanced when intangible assets (for example, human capital) are aligned with the customer strategy. From Figure 6.6, note the strategic theme for learning and growth: “a capable, motivated, and technologically enabled workforce.” When the three components of learning and growth—human, information, and organization capital—are aligned with the strategy, the firm is better able to mobilize action and execute that strategy. To recap, the balanced scorecard provides a series of measures and objectives across four perspectives: financial, customer, internal business process, and learning and growth. By developing mutually reinforcing objectives across these four areas, a strategy map can be used to tell the story of a business unit’s customer strategy and to highlight the internal business processes that drive performance. Summary Guided by a deep understanding of the needs of customers and the capabilities of competitors, market-driven organizations are committed to a set of processes, beliefs, and values that promote the achievement of superior performance by satisfying customers better than competitors do. Because many business-to-business firms have numerous divisions, product lines, and brands, three major levels of strategy exist in most large organizations: (1) corporate, (2) business level, and (3) functional. Moving down the strategy hierarchy, the focus shifts from strategy formulation to strategy implementation. Marketing is best viewed as the functional area that manages critical connections between the organization and customers. Business marketing planning must be coordinated and synchronized with corresponding planning efforts in other functional areas. Strategic plans emerge out of a bargaining process among functional areas. Managing conflict, promoting cooperation, and developing coordinated strategies are all fundamental to the business marketer’s role. A business model or concept consists of four major components: (1) a core strategy, (2) strategic resources, (3) the customer interface, and (4) the value network. The core strategy is the essence of how the firm competes, whereas strategic resources capture what the firm knows (core competencies), what the firm owns (strategic assets), and what employees actually do (core processes). Specifying the benefits to customers is a critical decision when designing a core strategy. The customer interface component refers to how customer relationship management strategies are designed and managed, whereas the value network component considers how partners and supply chain members can complement and strengthen the resource base of the firm. To establish and maintain a distinctive strategic positioning, a company should focus on profitability, rather than just revenue growth, deliver a unique value proposition, and configure activities—like new product development or customer relationship management—differently from rivals and in a manner that supports its value proposition. Successful execution involves linking strategy to operations, using tools and processes like the balanced scorecard and strategy map. The balanced scorecard converts a strategy goal into concrete objectives, and measures are organized into four different perspectives: financial, customer, internal business process, and learning and growth. 176 Part IV Formulating Business Marketing Strategy The approach involves identifying target customer segments, defining the differentiating customer value proposition, aligning the critical internal processes that deliver value to customers in these segments, and selecting the organizational capabilities necessary to achieve customer and financial objectives. Business marketers primarily emphasize one of the following value propositions or customer strategies: low total cost, product leadership, or system lock-in. A strategy map provides a visual representation of a firm’s critical objectives and the cause-and-effect relationships among them that drive superior organizational performance. Discussion Questions 1. Commenting on the decision-making process of his organization, a senior executive noted: “Sometimes the process is bloody, ugly, just like sausage meat being made. It’s not pretty to watch but the end results are not too bad.” Why do various functional interest groups often embrace conflicting positions during the strategic decision process? How are decisions ever made? 2. Describe how the primary focus of marketing managers at the corporate level differs from the focus marketing managers take at the business-unit or functional level. 3. A day in the life of a business marketing manager involves interactions with managers from other functions in the firm. First, identify the role of R&D, manufacturing, and logistics functions in creating and implementing marketing strategy. Next, describe some of the common sources of conflict that can emerge in cross-functional relationships. 4. Gary Hamel, a leading strategy consultant, contends that managers as well as Wall Street analysts like to talk about business models but few of them could define “what a business model or business concept really is.” Describe the major components of a business model and discuss how these components are linked to the benefits a firm provides to customers. 5. Select a firm such as FedEx, Apple, IBM, Boeing, GE, or Caterpillar and assess its business model. Develop a list of particular skills, resources, and strategies that are especially important to the selected firm’s strategic position. Give particular attention to those skills, resources, or characteristics that competitors would have the most difficulty in matching. 6. “Trying to be all things to all customers almost guarantees a weak strategic position for a firm.” Agree or disagree? Explain. 7. Strategy experts argue that effective and aligned internal business processes determine how value is created in an organization. Provide an illustration to demonstrate the point. 8. Describe why a business-to-business firm that plans to enter a new market segment may have to realign its internal business processes to succeed in this segment. Chapter 6 Business Marketing Planning: Strategic Perspectives 177 9. Describe how the learning and growth objectives in a balanced scorecard might differ for a firm pursuing a low-total-cost strategy versus one that emphasizes complete customer solutions. 10. The fourth component of the balanced scorecard, learning and growth, captures the intangible assets of the firm (for example, human, information, and organization capital). Describe the role these intangible assets might assume in executing strategy at FedEx or Google. Internet Exercises 1. 3M is a large, diversified, technology company that has numerous business units and manufactures thousands of products. Go to http://www.3m.com and a. identify the major market or industry sectors that the firm serves; b. describe a new product that 3M has recently introduced for the health-care sector. CASE Microsoft Targets Small and Mid-Sized Businesses37 By targeting small and medium-sized businesses, Microsoft hopes to capture a lucrative market sector, offsetting the slower growth among large-enterprise customers. This large and highly fragmented market includes small businesses with fewer than 50 employees and mid-sized firms with fewer than 500 employees. Microsoft’s chief executive, Steve Ballmer, views this market sector as the most vital and fastest-growing segment of the economy. To serve small and mid-market customers, Microsoft has developed a multiyear product plan that calls for increased investment in research and development. Challenging Intuit, Inc. Targeting small-business customers, Microsoft recently introduced Microsoft Office Small Business Accounting and Microsoft Office Small Business Management. These offerings are designed to enable small businesses to manage all their sales, marketing, and financial processes within an easy-to-use operating environment. The software is widely available through resellers and retail outlets, including Amazon.com, Best Buy, Office Depot, and Staples. Likewise, Dell offers the software preinstalled on selected Dell small-business computing systems. By introducing a small-business accounting program, Microsoft is taking direct aim at Intuit, Inc.’s widely used QuickBooks accounting software. Dan Levin, vice president of product management at Intuit, welcomed the competition, adding that the new accounting program “marks the fourth time Microsoft has attempted entry into the small business accounting software market.” Intuit is the undisputed leader in this market with its QuickBooks product line, but Microsoft wants to build volume in the small-business accounting market. Among the key battlegrounds where the two will compete head-to-head are • first-time accounting software users, most heavily concentrated in the one-tofour-employee segment, that still use basic checkbook accounting and manual processes; • the one-third of small businesses that upgrade or change their software annually; • the more than 500,000 new small businesses created in the United States each year. 37“Microsoft Goes After Small Business,” CNN Money, September 7, 2005, http://www.cnnmoney.com, and “Cashing in on the U.S. Small Business Accounting Market: Intuit and Microsoft Go Head to Head,” Access Markets International Partners, Inc., March 13, 2006, accessed at http://www.ami-partners.com on July 12, 2008. 178 Chapter 6 Business Marketing Planning: Strategic Perspectives 179 Discussion Questions 1. To succeed against rivals like Intuit that specialize in small-business customers, describe the differentiating value proposition that Microsoft should offer to customers. 2. Drawing on the balanced scorecard, describe how Microsoft might realign its internal business processes (for example, operations, customer, innovation management) to achieve targeted revenue and profit goals in the small- and mid-sized business segment. What steps might Intuit take to counter Microsoft’s challenges? CHAPTER 7 Business Marketing Strategies for Global Markets Business marketing firms that restrict their attention to the domestic market are overlooking enormous international market opportunities and a challenging field of competitors. After reading this chapter, you will understand: 1. how to capture the sources of global advantage in rapidly developing economies such as China and India. 2. the spectrum of international market-entry options and the strategic significance of different forms of global market participation. 3. the distinctive types of international strategy. 4. the essential components of a global strategy. 180 Chapter 7 Business Marketing Strategies for Global Markets 181 A recent Business Week article focused on the significant increase in global competition large U.S. industrial corporations face. Huge but relatively unknown firms from emerging markets are challenging Western firms in almost every global setting. From India’s Infosys Technologies (IT services) to Brazil’s Embraer (light jets), and from Taiwan’s Acer (computers) to Mexico’s Cemex (building materials), a new class of formidable competitors is rising. There are 25 worldclass emerging multinationals today and within 15 years, there will be at least 100 of them. The biggest challenge posed by these up-and-coming rivals will not be in Western markets, but within developing nations. That’s the arena of fastest global growth—and home to 80 percent of the world’s 6 billion consumers, hundreds of millions of whom have moved into the middle class. . . . The rise of these new multinationals will force American business marketers to rethink strategies for Third World product development, marketing, and links with local companies.1 Truly, business-to-business marketing is worldwide in scope, and the very existence of many business marketing firms will hinge on their ability to act decisively, compete aggressively, and seize market opportunities in rapidly expanding global economies. Numerous business marketing firms—such as GE, IBM, Intel, Boeing, and Caterpillar—currently derive much of their profit from global markets. They have realigned operations and developed a host of new strategies to strengthen market positions and compete effectively against the new breed of strong global rivals. This chapter will examine the need for, and the formulation of, global business marketing strategies. The discussion is divided into four parts. First, attention centers on rapidly developing economies, like China, and the sources of global advantage they can represent for business marketing firms. Second, international market-entry options are isolated and described. Third, “multidomestic” and “global” strategies are compared, and prescriptions provided for where they are most effectively applied. Fourth, the critical requirements for a successful global strategy are explored. Capturing Global Advantage in Rapidly Developing Economies2 A set of rapidly developing economies (RDEs) is reshaping the playing field and forcing business marketing executives to rethink their strategies and the scope of their operations. Key RDEs include, of course, China and India, as well as Mexico, Brazil, central and eastern Europe, and Southeast Asia. Let’s put the growth of these economies in perspective. Whereas the United States, western Europe, and Japan are projected to grow by roughly $3 trillion in collective gross domestic product (GDP) 1 Jeffrey E. Garten, “A New Threat to America, Inc.,” Business Week, July 25, 2005, p. 114. For a review of the top-100 international challengers, see Harold L. Sirkin, James W. Hemerling, and Arindam K. Bhattacharya, Globality: Competing with Everyone from Everywhere for Everything (New York: Business Plus, 2008). 2 This section is based on Arindam Bhattacharya, Thomas Bradtke, Jim Hemerling, Jean Lebreton, Xavier Mosquet, Immo Rupf, Harold L. Sirkin, and Dave Young, “Capturing Global Advantage: How Leading Industrial Companies Are Transforming Their Industries by Sourcing and Selling in China, India, and Other Low-Cost Countries,” The Boston Consulting Group, Inc., April 2004, accessed at http://www.bcg.com. 182 Part IV Formulating Business Marketing Strategy from 2004 to 2010, the key RDEs will grow by more than $2 trillion. Specifically, China’s GDP is expected to increase by $750 billion, central and eastern Europe’s by $450 billion, Southeast Asia’s by $350 billion, India’s by $300 billion, Mexico’s by $250 billion, and Brazil’s by $200 billion. During this period, as highly developed economies like the United States and Japan experience annual GDP growth slightly above 2 percent, China will grow four times as fast, and India, Southeast Asia, and Mexico three times as fast. For example, Vietnam has become an extremely attractive investment opportunity for many business-to-business firms. Vietnam was admitted to the World Trade Organization in 2007, and the country enjoys a solid base of well-educated workers and a government determined to transform the country into a powerful economic entity. It is one of the fastest-growing economies, with a growth in GDP in 2007 of over 8 percent. Not only does Vietnam offer an excellent base for manufacturing operations, it has also become a very attractive market for business-to-business marketers. With a government willing to transform the country into private industrial operations, it is a country that cannot be ignored by firms looking for lower-cost manufacturing opportunities and large markets. While representing a potentially attractive market opportunity, RDEs also present a formidable competitive challenge to firms in many industries. The migration of sourcing, manufacturing, and service operations from high-cost countries (for example, the United States and western Europe) to low-cost countries (for example, China, Mexico, and India) is well under way and accelerating. In the United States alone, the value of offshore arrangements has increased steadily: The cumulative value of outsourcing contracts rose from $50 billion in 2002 to more than $225 billion in 2007.3 In turn, imports from these rapidly developing economies are making substantial inroads into core industrial product categories that were historically thought to be protected from such competition. However, leading firms like GE, Microsoft, Cisco, Apple, and Siemens are seizing opportunities by capturing sources of global advantage. In industry after industry, firms are under enormous pressure to make the move to global operations. Mapping Sources of Global Advantage4 A firm can globalize its cost structure through the migration of sourcing, manufacturing, R&D, and service operations from a high-cost country to an RDE. In creating advantaged global operations, companies might conduct R&D in the United States, manufacture some product lines in the United States and others in China and Mexico, and locate customer service in India and Ireland. “Significant portions of manufacturing are expected to remain advantaged in their current locations. Reasons for staying in highercost locations might include the need to safeguard intellectual property content, the importance of collocation with customers, or the requirement to use local content.”5 3 David Jacoby and Bruna Fiqueiredo, “The Art of High-Cost Country Sourcing,” Supply Chain Management Review 12 (May/June 2008): p. 33. 4 Unless otherwise noted, this section draws on Jim Hemerling, Dave Young, and Thomas Bradtke, “Navigating the Five Currents of Globalization: How Leading Companies Are Capturing Global Advantage,” BCG Focus (April 2005), The Boston Consulting Group, Inc., accessed at http://www.bcg.com. 5 Battacharya et al., “Capturing Global Advantage,” p. 7. Chapter 7 Business Marketing Strategies for Global Markets 183 Firms that quickly and intelligently seize global opportunities can secure three forms of competitive advantage: (1) a cost advantage, (2) a market access advantage, and (3) a capabilities advantage. The Cost Advantage The major driver for a move to RDE sourcing remains very large—and sustainable— cost advantages from two primary sources: lower operating costs and lower capital investment requirements. The savings are striking. Jim Hemerling and his colleagues at the Boston Consulting Group assert that companies that globalize their cost structures by including RDEs can realize savings of 20 to 40 percent in the landed costs of their products. The landed cost reflects the realized net savings after logistics costs, other management costs, and import duties involved in moving the product from the RDE (for example, China) to the market destination (for example, the United States). In addition, the capital needed to create a manufacturing facility in an RDE is 20 to 40 percent lower than in a highly developed economy. In addition to the cost and investment advantages, another driver of lower costs has emerged in recent years: government subsidies. Subsidies in the form of direct payment to companies may allow them to price their products below competitive prices and enjoy distinct advantages in other global markets. Lower Operating Costs The difference in labor costs is a major component of the RDE cost advantage. Depending on the industry, the factory location, and the nature of employee benefits, a factory worker in the United States or Europe costs $15 to $30 or more per hour. By contrast, a factory worker in China earns $1 per hour, whereas in Mexico and in central and eastern Europe, workers earn $2 to $8 per hour. Figure 7.1 displays the realized cost savings (that is, 30 percent) for industrial products such as electric motors, transformers, and compressors that are manufactured in a RDE. Observe that companies operating in a RDE save not only directly on labor costs but also indirectly on domestic materials and components. Business Process Outsourcing When the focus shifts from products to highly labor-intensive sectors, such as services, the cost advantage of outsourcing to a RDE is up to 60 percent. India now represents the global market leader in offshore business-process outsourcing. Included here are not only transactional processes like call centers but also core industrial processes such as R&D and supply chain management. A strong telecommunications infrastructure, coupled with large numbers of highly educated English-speaking managers, engineers, and workers, constitute key advantages for India. By outsourcing call centers to India, General Electric’s consumer finance business saved 30 to 35 percent and American Express had savings of more than 50 percent. Will the Cost Gap Persist? Experts suggest that the differential in labor rates between RDEs and developed countries will remain substantial for the foreseeable future, even if they grow at dramatically different rates. Wage growth in China and India will be limited by the large number of underemployed people in both countries. Likewise, companies that operate in RDEs have been able consistently to lower purchasing costs over time, achieving cost savings that significantly exceed those that are normally found in the West. 184 Part IV Formulating Business Marketing Strategy FIGURE 7.1 RDES OFFER A SUBSTANTIAL COST ADVANTAGE OVER HIGHLY DEVELOPED ECONOMIES Cost savings Additional costs 120 100 100 20–25 5–10 Index 80 10–15 60 10 0–5 0–5 50 Scale Special Incentives RDE manufacturing cost 5 5 70 40 20 0 Manufacturing Labor cost in a highly developed economy Depreciation Materials, components, and tooling Logistics costs Other (transportation, management additional costs inventory, and expediting) Import duties Landed cost from an RDE SOURCE: Jim Hemerling, Dave Young, and Thomas Bradtke, “Navigating the Five Currents of Globalization: How Leading Companies Are Capturing Global Advantage,” BCG Focus, January 2005, The Boston Consulting Group, Inc., accessed at http://www.bcg.com. Copyright © The Boston Consulting Group, Inc. 2005. All rights reserved. Reprinted by permission. Lower Capital Investment Requirements Another important—and sometimes overlooked—source of the RDE cost advantage is lower capital investment requirements for plants and equipment. While lower operating costs benefit a firm’s profit and loss (P&L) statement, lower capital investment requirements also represent significant savings on the balance sheet. The combination of lower product costs and lower capital investment requirements can boost the total return on investment. Figure 7.2 shows the typical cost differential for an industrial installation (for example, factory) in a RDE versus one in a highly developed economy. Observe that a factory in a RDE can be built for just 70 percent of the investment level needed in a highly developed economy. These capital savings result from the lower cost of infrastructure (15 percent savings), the lower cost of local machinery and equipment (10 percent), and the opportunity to substitute labor for costly technology (10 percent). After accounting for the higher costs (5 percent) of imported machinery, the net capital savings are 30 percent in the RDE (see Figure 7.2). Subsidies Many assume that China’s cost advantage in manufacturing comes from cheap labor. But in China’s burgeoning steel industry, research suggests that massive government energy subsidies, not other factors, keep prices down. These subsidies have broad implications for how companies compete and collaborate with Chinese Chapter 7 FIGURE 7.2 185 Business Marketing Strategies for Global Markets RDES OFFER A SIGNIFICANT CAPITAL ADVANTAGE OVER HIGHLY DEVELOPED ECONOMIES Capital savings Additional capital needed 120 100 15 100 10 10 Index 80 5 70 Higher cost of imported machinery and equipment Investment level in an RDE 60 40 20 0 Investment level in a highly developed economy Lower cost of infrastructure (land and buildings) Lower cost of local machinery and equipment Less machinery and equipment SOURCE: Jim Hemerling, Dave Young, and Thomas Bradtke, “Navigating the Five Currents of Globalization: How Leading Companies Are Capturing Global Advantage,” BCG Focus, January 2005, The Boston Consulting Group, Inc., accessed at http://www.bcg.com. Copyright © The Boston Consulting Group, Inc. 2005. All rights reserved. Reprinted by permission. businesses.6 The country has now become the world’s largest steel exporter by volume and it remains the world’s largest consumer and producer of steel, with 40 percent of global production. How did China make these astonishing gains so quickly and manage to sell steel for about 19 percent less than steel from U.S. and European companies? Labor accounts for less than 10 percent of the costs of producing Chinese steel, and Chinese steel does not appear to rely on scale economies, supply chain proximities, or technological efficiencies to lower its costs. The answer was a $27 billion energy subsidy (for coal) from the Chinese government. Since energy represents a much larger cost than labor in steel production, the subsidy provides a huge global cost advantage for the Chinese steel industry. The Hidden Cost of RDE Operations The cost advantages gained through operations in a RDE can be eroded by additional costs if companies fail to recognize them and aggressively control them. Among these hidden costs are7 One-time setup costs that include the typical costs of establishing a new business, such as identifying and qualifying suppliers, creating a reliable logistics chain, and training employees; 6 C. V. Usha and George T. Haley, “Subsidies and the China Price,” Harvard Business Review, 7 Battacharya et al., “Capturing Global Advantage,” pp. 20–21. 86 (June, 2008): p. 25. 186 Part IV Formulating Business Marketing Strategy Ongoing RDE risk management costs related to monitoring the quality of suppliers, managing inventory in a longer-than-usual logistics chain, and hedging exchange rate fluctuations; Exit costs related to closing high-cost production or service facilities, including asset write-offs and related restructuring costs, as well as “bad will” costs (for example, damaged relations with unions) in the home country. A good example of some of the hidden costs in RDE operations is the experience of Intel in China. Intel built a large factory in the central region of China in an effort to accommodate Chinese government pressure to develop the interior of the country. Intel did enjoy the advantage of very low cost labor and lower investment cost, but the huge cost of transportation was not recognized until after the factory was operating. Intel was unable to use large jumbo jets to ship finished computer chips due to the lack of a suitable airport to accommodate Boeing 747s. Moving chips by truck was also challenging because the specialized “air-ride” trucks required for shipping fragile computer chips were not abundant in China. In fact, only 15 airride trucks could be found in the entire country! It took many months until more air-ride trucks became available and a new airport could be built. This obvious setback was a costly lesson in dealing with the lack of infrastructure in RDEs. In the truck construction industry, some firms believe that to be able to source in China, they must have a “piece price” savings of at least 20 percent in order to offset the associated costs and risks.8 In most cases, business-to-business firms do not exit their home-country operations entirely. They prefer instead to maintain the best home-country operations while moving only the least efficient to RDEs to remain competitive and to secure market access. The Market Access Advantage Although companies traditionally relocated manufacturing operations to RDEs to gain cost advantages, once they are established in these countries, they are ideally positioned to serve fast-growing local markets. The striking results that GE Healthcare achieved in China illustrate the market access advantage. GE Healthcare entered the market by transferring technology to local Chinese R&D centers, which then developed “Chinese” versions of GE medical equipment that offered roughly 80 percent of the performance of Western systems at just 50 percent of the price. Because these products met local needs, GE Healthcare became the market leader in China. Furthermore, the China-developed products also appealed to customers in some Western countries where certain market segments found compelling value in the unique trade-off between the products’ price and functionality. China’s Growing Role For many industrial product categories, China is already the world’s largest market. China is the largest market for machine tools, the second largest for power transmissions and distribution equipment, and the second largest 8 Rick Weber, “SC Goes Global,” Body Builders, 48 (March, 2007): p. 52 Chapter 7 Business Marketing Strategies for Global Markets 187 for energy consumption. On the consumer product side, China is the world’s largest market for cell phones, air conditioners, and refrigerators and represents a large and rapidly growing market for personal computers, automobiles, and consumer electronics products. Other RDEs, like India, are also growing explosively. For Cummins Inc., the diesel engine maker, China and India each represent a lucrative market today. But by 2010, Cummins projects revenues of $2 billion from India and $3 billion from China.9 Following Key Customers to RDEs Many small and mid-sized companies are following their customers to RDEs. For example, Phoenix Electric Manufacturing Company, a Chicago-based producer of electric motors for power tools, kitchen appliances, and other products, added a factory in China.10 The move enabled Phoenix Electric to retain its largest customers—GE and Emerson Electric—which have shifted most of their consumer-electronics production to the area. Similarly, Hiwasse Manufacturing, an Arkansas-based manufacturer of steel products used in the control panels of refrigerators, ovens, and other appliances, added a facility in Mexico near a GE appliance manufacturing facility.11 A Twofold Strategy As major industrial sectors relocate manufacturing operations to RDEs, business-to-business firms that supply these sectors must take decisive action. Jim Hemerling and his associates at the Boston Consulting Group provide this advice: Most companies need to develop a twofold strategic plan: to fill market gaps at home, and to follow selected customers to their new locations. In our experience, it is rarely feasible to pursue only one or the other.12 For example, gaps can be filled at home by pursuing new lines of business or new product or service opportunities where the home country advantage can be defended. In turn, when moving to a RDE, suppliers must adjust their operating models to fully capture the cost advantages. The Capabilities Advantage To reinforce the cost advantage of operating in RDEs, top-performing global companies capture second-order benefits by tapping into the rapidly developing base of human talent in these countries. China and India each add over 350,000 science and engineering graduates to their talent pool each year. In 2008, at least 5.59 million students will graduate from colleges in China, 13 percent more than last year, according to the Chinese Ministry of Education.13 In fact, there are so many Chinese students attending college, that 700,000 of the 2007 college graduates were unable to find a job after they graduated, reinforcing the magnitude of the pool of educated talent available to firms locating in China. Many global companies, like GE, Microsoft, Motorola, 9 Pete Engardio and Michael Arndt, “How Cummins Does It,” Business Week, August 22–29, 2005, pp. 82–83. 10 Dexter Roberts and Michael Arndt, “It’s Getting Hotter in the East,” Business Week, August 22–29, 2005, pp. 78–81. 11 Louis Uchitelle, “If You Can Make It Here . . . ,” New York Times, September 4, 2005, p. B-5. 12 Hemerling, Young, and Bradtke, “Navigating the Five Currents of Globalization,” pp. 9–10. 13 “Getting a Job May Be Tougher for Graduates,” China Daily, July 11, 2008, p. 11. 188 Part IV Formulating Business Marketing Strategy INSIDE BUSINESS MARKETING How Offshore Outsourcing Affects Customer Satisfaction— and a Company’s Stock Price! Recent research suggests that sending customer service abroad negatively affects customer satisfaction. Jonathan Whitaker and his research colleagues analyzed the outsourcing activities of 150 North American companies and business units. As a group, those firms that outsourced saw a drop in their score on the American Consumer Satisfaction Index. Importantly, the declines in consumer satisfaction scores were roughly the same whether companies outsourced customer service domestically or overseas. Customer satisfaction scores tend to move in the same direction as companies’ stock prices. Based on this historical relationship, the average decline in consumer satisfaction found at companies outsourcing customer service is associated with a roughly 1 to 5 percent decline in a company’s market capitalization, depending on the industry in which the company operates. That’s a steep price! By the way, market capitalization is a measure of the value of a firm (that is, total outstanding shares 3 stock price). To improve the quality of outsourced customer service, special attention should be given to insuring that the provider has all the information required to help the customer and is fully empowered to do so. Interestingly, the researchers found that “backoffice offshoring had no effect on overall customer satisfaction. So the savings a company garners this way are not offset by dissatisfaction among customers.” SOURCE: Jonathan Whitaker, M.S. Krishnan, and Claes Fornell, “Customer Service: How Offshore Outsourcing Affects Customer Satisfaction,” The Wall Street Journal, July 7, 2008, p. R4. and Siemens, have created R&D centers in both India and China. For example, Motorola employs several thousand engineers in China and operates a large R&D center in Beijing. Leading companies can make use of this capabilities advantage to accomplish the following: • Improve research and development: The much lower cost of engineers and skilled technicians in RDEs allows companies to increase dramatically the amount of R&D they do for a given budget level. • Address unmet customer needs: The opportunity to make greater use of skilled labor in place of machines allows companies to manufacture customized products less expensively than would be feasible in a more automated setting. • Tailor products and services to the burgeoning local markets in RDEs: To illustrate, Motorola’s Beijing R&D center develops cell phones for the local market—the largest handset market in the world.14 Unique RDE Risks In a remote area of India, a group of gun-wielding commandos emerged from the dense forest in India’s Chhattisgarh state. The guerrillas descended on an iron ore processing plant owned by Essar Steel, one of India’s biggest companies. There the attackers torched the heavy machinery on the site, plus 53 buses and trucks. The guerrillas left a note that basically said, “Stop shipping local resources out 14 Roberts and Arndt, “It’s Getting Hotter in the East,” pp. 78–81. Chapter 7 TABLE 7.1 Business Marketing Strategies for Global Markets 189 DETERMINING WHICH PRODUCTS TO OUTSOURCE TO RAPIDLY DEVELOPING ECONOMIES (RDES) AND WHICH TO KEEP AT HOME Selected Criteria Maintain Home-Based Manufacturing Relocate to RDEs Labor Contract Growth of Demand in Home Market Size of RDE Market Degree of Standardization Intellectual Property Content Logistical Requirements Low Low Low Low High High High High High High Low Low SOURCE: Adapted from Arindam Bhattacharya et al., “Capturing Global Advantage: How Leading Industrial Companies Are Transforming Their Industries by Sourcing and Selling in China, India, and Other Low-Cost Countries,” The Boston Consulting Group, Inc., April 2004, pp. 26–30, accessed at http://www.bcg.com. of the state—or else.” The assault on the Essar facility was the work of Naxalites— Maoist insurgents who seek the violent overthrow of the state and who despise India’s landowning and business classes. The Naxalites may be a major threat to India’s economic power, potentially more damaging to Indian companies, foreign investors, and the state than pollution, crumbling infrastructure, or political gridlock.15 This is an example of the serious risks that can appear in RDEs. The Outsourcing Decision16 The decision to relocate manufacturing, R&D, or customer service to RDEs is a strategic decision involving a host of economic, competitive, and environmental considerations. Clearly, some products and services are better candidates for outsourcing than others. What Should Go? The criteria that favor relocation to RDEs include products or services with high labor content, high growth potential, large RDE markets, and standardized manufacturing or service delivery processes (Table 7.1). These criteria reflect each of the sources of global advantage we have explored. For services, the processes most easily relocated are those that have well-defined process maps or those that are rule-based (for example, the established protocol a customer service call center uses). What Should Not Go? Products and services that should remain at home include “those for which protection of intellectual property is critical, those with extreme logistical requirements, those with very high technology content or performance requirements, and those for which customers are highly sensitive to the location of production” (for example, certain military contracts).17 Concerns about intellectual 15 “In India, Death to Global Business,” Business Week; May 19, 2008, pp. 44–47. 16 Battacharya et al., “Capturing Global Advantage,” pp. 26–30. 17 Ibid., p. 29. 190 Part IV Formulating Business Marketing Strategy FIGURE 7.3 SPECTRUM OF INVOLVEMENT IN GLOBAL MARKETING Low Commitment Exporting High Commitment Contracting Low Complexity Strategic Alliance Joint Venture Multidomestic Strategy Global Strategy High Complexity property (IP) theft is a major issue in most RDEs, particularly in China. Experts suggest that some multinational companies in China are losing the battle to protect their IP, largely because they emphasize legal tactics rather than including IP directly into their strategic and operational decisions. By carefully analyzing and selecting which products and technologies to sell in China, the best companies reduce the chance that competitors will steal their IP. Global Market Entry Options18 To develop effective global marketing strategy, managers must evaluate the alternative ways that a firm can participate in international markets. The particular mode of entry should consider the level of a firm’s experience overseas and the stage in the evolution of its international involvement. Figure 7.3 illustrates a spectrum of options for participating in global markets. They range from low-commitment choices, such as exporting, to highly complex levels of participation, such as global strategies. Each is examined in this section. Exporting An industrial firm’s first encounter with an overseas market usually involves exporting because it requires the least commitment and risk. Goods are produced at one or two home plants, and sales are made through distributors or importing agencies in each country. Exporting is a workable entry strategy when the firm lacks the resources to make a significant commitment to the market, wants to minimize political and economic risk, or is unfamiliar with the country’s market requirements and cultural norms. Exporting is the most popular global market entry option among small and medium-sized firms.19 Many companies begin export activities haphazardly, without carefully screening markets or options for market entry. These companies may or may not have a measure of success, and they might overlook better export opportunities. If early export 18 The following discussion is based on Franklin R. Root, Entry Strategy for International Markets (Lexington, MA: D. C. Heath, 1987); and Michael R. Czinkota and Ilka A. Ronkainen, International Marketing, 2d ed. (Hinsdale, IL: Dryden Press, 1990). 19 Jery Whitelock and Damd Jobber, “An Evaluation of External Factors in the Decision of UK Industrial Firms to Enter a New Non-Domestic Market: An Exploratory Study,” European Journal of Marketing 38 (11/12, 2004): p. 1440. Chapter 7 Business Marketing Strategies for Global Markets 191 efforts are unsuccessful because of poor planning, the company may be misled into abandoning exporting altogether. Formulating an export strategy based on good information and proper assessment increases the chances that the best options will be chosen, that resources will be used effectively, and that efforts will consequently be carried through to success. The Commercial Service of the Department of Commerce has developed and maintains a network of international trade specialists in the United States to help American companies export their products and conduct business abroad. Trade specialists operate offices known as Export Assistance Centers (EACs) located in almost 100 cities in the United States and Puerto Rico that assist small and medium-sized companies. EACs are known as “one-stop shops” because they combine the trade and marketing expertise and resources of the Commercial Service along with the finance expertise and resources of the Small Business Administration (SBA) and the Export-Import Bank. Thus they provide companies with a wide array of services in one location, and they also maximize resources by working closely with state and local government as well as with private partners to offer companies a full range of expertise in international trade, marketing, and finance.20 Although it preserves flexibility and reduces risk, exporting may limit the future prospects for growth in the country. First, exporting involves giving up direct control of the marketing program, which makes it difficult to coordinate activities, implement strategies, and resolve conflicts with customers and channel members. George Day explains why customers may sense a lack of exporter commitment: In many global markets customers are loath to form long-run relationships with a company through its agents because they are unsure whether the business will continue to service the market, or will withdraw at the first sign of adversity. This problem has bedeviled U.S. firms in many countries, and only now are they living down a reputation for opportunistically participating in many countries and then withdrawing abruptly to protect shortrun profits.21 Contracting A somewhat more involved and complex form of international market entry is contracting. Included among contractual entry modes are (1) licensing and (2) management contracts. Licensing Under a licensing agreement, one firm permits another to use its intellectual property in exchange for royalties or some other form of payment. The property might include trademarks, patents, technology, know-how, or company name. In short, licensing involves exporting intangible assets. As an entry strategy, licensing requires neither capital investment nor marketing strength in foreign markets. This lets a firm test foreign markets without a major commitment of management time or capital. Because the licensee is typically a local 20 A Basic Guide to Exporting, the U.S. Department of Commerce with the assistance of Unz & Co., Inc. http://www .export.gov/exportbasics/index.asp, accessed on July 18, 2008. 21 George S. Day, Market Driven Strategy: Processes for Creating Value (New York: The Free Press, 1990), p. 272. 192 Part IV Formulating Business Marketing Strategy company that can serve as a buffer against government action, licensing also reduces the risk of exposure to such action. With increasing host-country regulation, licensing may enable the business marketer to enter a foreign market that is closed to either imports or direct foreign investment. Licensing agreements do pose some limitations. First, some companies are hesitant to enter into license agreements because the licensee may become an important competitor in the future. Second, licensing agreements typically include a time limit. Although terms may be extended once after the initial agreement, many foreign governments do not readily permit additional extensions. Third, a firm has less control over a licensee than over its own exporting or manufacturing abroad. Management Contracts To expand their overseas operations, many firms have turned to management contracts. In a management contract the industrial firm assembles a package of skills that provide an integrated service to the client. When equity participation, either full ownership or a joint venture, is not feasible or is not permitted by a foreign government, a management contract provides a way to participate in a venture. Management contracts have been used effectively in the service sector in such areas as computer services, hotel management, and food services. Michael Czinkota and Ilka Ronkainen point out that management contracts can “provide organizational skills not available locally, expertise that is immediately available rather than built up, and management assistance in the form of support services that would be difficult and costly to replicate locally.”22 One specialized form of a management contract is a turnkey operation. This arrangement permits a client to acquire a complete operational system, together with the skills needed to maintain and operate the system without assistance. Once the package agreement is online, the client owns, controls, and operates the system. Management contracts allow firms to commercialize their superior skills (know-how) by participating in the international market. Other contractual modes of entry have grown in prominence in recent years. Contract manufacturing involves sourcing a product from a producer located in a foreign country for sale there or in other countries. Here assistance might be required to ensure that the product meets the desired quality standards. Contract manufacturing is most appropriate when the local market lacks sufficient potential to justify a direct investment, export entry is blocked, and a quality licensee is not available. Strategic Global Alliances (SGA) A strategic global alliance (SGA) is a business relationship established by two or more companies to cooperate out of mutual need and to share risk in achieving a common objective. This strategy works well for market entry or to shore up existing weaknesses and increase competitive strengths. A U.S. firm with a reliable supply base might partner with a Japanese importer that has the established distribution channels and customer base in Japan to form a strong entry into the Japanese market.23 Alliances 22 Czinkota and Ronkainen, International Marketing, p. 493. 23 Laura Delaney, “Expanding Your Business Globally,” MultiLingual, 19 (April, 2008): pp. 10–11. Chapter 7 Business Marketing Strategies for Global Markets 193 offer a number of benefits, such as access to markets or technology, economies of scale in manufacturing and marketing, and the sharing of risk among partners (see Chapter 4). Although offering potential, global strategic alliances pose a special management challenge. Among the stumbling blocks are these:24 • Partners are organized quite differently for making marketing and product design decisions, creating problems in coordination and trust. • Partners that combine the best set of skills in one country may be poorly equipped to support each other in other countries, leading to problems in implementing alliances on a global scale. • The quick pace of technological change often guarantees that the most attractive partner today may not be the most attractive partner tomorrow, leading to problems in maintaining alliances over time. Jeffrey Dyer and his colleagues conducted an in-depth study of 200 corporations and their 1,572 alliances and found that, on average, the top 500 global companies each participate in 60 major strategic alliances.25 Fraught with risk, almost half of these alliances fail. Recall from Chapter 4 that firms that excel at generating value from alliances have a dedicated strategic-alliance function. A dedicated function acts as a focal point for learning and for leveraging feedback from prior and ongoing alliances. The alliance function ensures that metrics are created and applied to monitor the performance of all of their alliances, domestic and global. Joint Ventures In pursuing international entry options, a corporation confronts a wide variety of ownership choices, ranging from 100 percent ownership to a minority interest. Frequently, full ownership may be a desirable, but not essential, prerequisite for success. Thus a joint venture becomes feasible. The joint venture involves a jointownership arrangement (between, for example, a U.S. firm and one in the host country) to produce and/or market goods in a foreign market. In contrast to a strategic alliance, a joint venture creates a new firm. Some joint ventures are structured so that each partner holds an equal share; in others, one partner has a majority stake. The contributions of partners can also vary widely and may include financial resources, technology, sales organizations, know-how, or plant and equipment. Representing a successful relationship is the 50-50 joint venture between Xerox Corporation and Tokyo-based Fuji Photo Film Company. Through the joint venture, Xerox gained a presence in the Japanese market, learned valuable quality management skills that improved its products, and developed a keen understanding of important Japanese 24 Thomas J. Kosnik, “Stumbling Blocks to Global Strategic Alliances,” Systems Integration Age, October 1988, pp. 31–39. See also Eric Rule and Shawn Keon, “Competencies of High-Performing Strategic Alliances,” Strategy & Leadership, 27 (September–October 1998): pp. 36–37. 25 Jeffrey Dyer, Prashant Kale, and Harbir Singh, “How To Make Strategic Alliances Work,” MIT Sloan Management Review 42 (2001): pp. 37–43. 194 Part IV Formulating Business Marketing Strategy ETHICAL BUSINESS MARKETING The Bribery Dilemma in Global Markets Global marketing managers often face a dilemma when home-country regulations clash with foreign business practices. A good case in point is the aerospace industry. U.S. government policies about bribery by private companies have affected aircraft sales in some countries. The U.S. Foreign Corrupt Practices Act (FCPA) of 1977 prohibits payments by U.S. companies and individuals, including exporters of aircraft, to obtain or retain business and has had a major effect on how U.S. companies conduct global business. Until 1999, European laws on transnational bribery were nonexistent. Accordingly, some European aerospace manufacturers were widely alleged to have bribed foreign public officials to win sales at the expense of their U.S. competitors. Currently, the U.S. government and the Organization for Economic Cooperation and Development (OECD) Working Group on Bribery are trying to remove the major obstacles to implementation of the OECD’s antibribery convention. The U.S. government is also seeking to strengthen OECD and other multilateral and bilateral disciplines related to bribery and corruption of public officials. Interestingly, recent press reports allege that European aerospace companies are among the business groups pressing their governments to relax antibribery rules. To the extent that bribery and anticorruption disciplines and enforcement in Europe remain weaker than under the U.S. Foreign Corrupt Practices Act, European aerospace companies will enjoy a competitive advantage in sales competitions to foreign governments or government-controlled airlines. SOURCE: Joseph H. Bogosian, “Global Market Factors Affecting U.S. Jet Producers,” Federal Document Clearing House Congressional Testimony, Capital Hill Hearing Testimony, House Transportation and Infrastructure, May 25, 2005. rivals such as Canon, Inc., and Ricoh Company. This joint venture has thrived for more than three decades.26 Advantages Joint ventures offer a number of advantages. First, joint ventures may open up market opportunities that neither partner could pursue alone. Kenichi Ohmae explains the logic: If you run a pharmaceutical company with a good drug to distribute in Japan but have no sales force to do it, find someone in Japan who also has a good product but no sales force in your country. You get double the profit by putting two strong drugs through your fixed cost sales network, and so does your new ally. Why duplicate such high expenses all down the line? . . . Why not join forces to maximize contribution to each other’s fixed costs?27 Second, joint ventures may provide for better relationships with local organizations (for example, local authorities) and with customers. By being attuned to the host country’s culture and environment, the local partner may enable the joint venture to respond to changing market needs, be more aware of cultural sensitivities, and be less vulnerable to political risk. 26 David P. Hamilton, “United It Stands—Fuji Xerox Is a Rarity in World Business: A Joint Venture That Works,” The Wall Street Journal, September 26, 1996, p. R19. 27 Kenichi Ohmae, “The Global Logic of Strategic Alliances,” Harvard Business Review 67 (March–April 1989): p. 147. Chapter 7 Business Marketing Strategies for Global Markets 195 The Downside Problems can arise in maintaining joint-venture relationships. A study suggests that perhaps more than 50 percent of joint ventures are disbanded or fall short of expectations.28 The reasons involve problems with disclosing sensitive information, disagreements over how profits are to be shared, clashes over management style, and differing perceptions on strategy. Mihir Desai, Fritz Foley, and James Hines studied more than 3,000 American global companies and report that joint ventures appear to be falling out of favor.29 Why? Increasing forces of globalization such as fragmented production processes make the decision to not collaborate pay off. If a firm is considering a joint venture, Desai, Foley, and Hines suggest that they first isolate the reasons for considering a joint venture and make sure that “they can’t buy the required services or that knowledge through an arms-length contract that doesn’t require sharing ownership. . . . Second, explicitly lay out expectations for the partners in legal and informal documents prior to the creation of the entity so that it’s clear what each party is providing. Third, try out partners without setting up a joint venture by conducting business with them in some way. . . . Finally, specify simple exit provisions at the onset and then don’t be afraid to walk and go it alone.” Choosing a Mode of Entry For an initial move into the global market, the full range of entry modes, presented earlier, may be considered—from exporting, licensing, and contract manufacturing to joint ventures and wholly owned subsidiaries. In high-risk markets, firms can reduce their equity exposure by adopting low-commitment modes such as licensing, contract manufacturing, or joint ventures with a minority share. Although nonequity modes of entry—such as licensing or contract manufacturing—involve minimal risk and commitment, they may not provide the desired level of control or financial performance. Joint ventures and wholly owned subsidiaries provide a greater degree of control over operations and greater potential returns. Once operations are established in a number of foreign markets, the focus often shifts away from foreign opportunity assessment to local market development in each country. This shift might be prompted by the need to respond to local competitors or the desire to more effectively penetrate the local market. Planning and strategy assume a country-by-country focus. Multidomestic versus Global Strategies Business marketing executives are under increasing pressure to develop globally integrated strategies to achieve efficiency and rationalization across their geographically dispersed subsidiaries. As such, the challenge of internationalizing the firm is not in providing a homogeneous offering across markets, but rather in finding the best balance between local adaptation (a multidomestic strategy) and global optimization, where one integrated strategy is applied globally.30 Multinational firms have traditionally managed 28 Arvind Parkhe, “Building Trust in International Alliances,” Journal of World Business 33 (Winter 1998): pp. 417–437. 29 Mihir A. Desai, C. Fritz Foley, and James Hines, “The Costs of Shared Ownership: Evidence From International Joint Ventures,” Journal of Financial Economics 73 (2004): pp. 323–374. 30 G. Tomas M. Hult, S. Tamer Cavusgil, Seyda Deligonul, Tunga Kiyak, and Katarina Lagerström, “What Drives Performance in Globally Focused Marketing Organizations? A Three-Country Study,” Journal of International Marketing 15 (2007): pp. 58–85. 196 Part IV Formulating Business Marketing Strategy B2B TOP PERFORMERS General Electric Aircraft Engines: Global Strategy Means Help Your Customers General Electric’s (GE’s) Aircraft Engine Division must maintain a very large global presence, as it markets jet engines to almost every airline in the world. Although most large airlines purchase their aircraft from either Boeing or Airbus, the individual airline makes the choice as to the jet engine manufacturer. Thus, Singapore Air can choose between Pratt & Whitney, Rolls-Royce, or GE. The stakes are high in the industry, given that a particular airline may purchase hundreds of aircraft over a relatively short period of time. The challenges are significant for the jet engine manufacturers: They must have a solid relationship with aircraft manufacturers like Boeing and Airbus, but just as important, they need to expend considerable effort to woo and then keep the airlines as customers. Making GE’s job tougher are the global aspects of these relationships. First, Boeing is an American firm and Airbus is a joint venture of firms from several European Union countries. Several other airframe manufacturers are located in Brazil, Canada, and China—and these manufacturers cater to the smaller, regional airlines that fly 50- to 100-seat jets. Even more daunting is the fact that there are close to 80 airlines located all over the world, only a handful of which are U.S.-based. A major element in GE’s marketing strategy is to offer assistance to global customers in creative ways. For example, one new customer is a Chinese airframe manufacturer that had not yet built its first airplane when GE began interacting with company executives! The firm’s first airplane would not roll off the assembly line until 2008, yet GE began building relationship ties with this company in 2003—in a subtle way. Because the Chinese airframe manufacturer is a brand-new company, key managers lacked experience in all the key aspects of business-tobusiness marketing. GE’s response: help educate the airframe manufacturer’s sales and marketing personnel in all facets of business-to-business marketing. One element of this approach was to invite the entire marketing and sales team to GE’s U.S. headquarters for a two-week seminar on B2B marketing. Follow-up would take place in China at a later date to review assignments and projects given to the participants at the first seminar. GE will also work hand-in-hand with the Chinese sales team as they begin making sales calls on the airlines that are potential buyers of their aircraft. GE’s efforts illustrate the challenges of selling in rapidly growing global markets where potential customers are rather inexperienced in many facets of business. The challenges for GE are complex, as it must deal with the cultural and business process issues of its Chinese customer, as well as those of all the airlines around the world to whom the Chinese firm will sell the airplanes. operations outside their home country with multidomestic strategies that permit individual subsidiaries to compete independently in their home-country markets. The multinational headquarters coordinates marketing policies and financial controls and may centralize R&D and some support activities. Each subsidiary, however, resembles a strategic business unit that is expected to contribute earnings and growth to the organization. The firm can manage its international activities like a portfolio. Examples of multidomestic industries include most types of retailing, construction, metal fabrication, and many services. In contrast, a global strategy seeks competitive advantage with strategic choices that are highly integrated across countries. For example, features of a global strategy might include a standardized core product that requires minimal local adaptation and that is targeted on foreign-country markets chosen on the basis of their contribution to globalization benefits. Prominent examples of global industries are automobiles, commercial aircraft, consumer electronics, and many categories of industrial machinery. Chapter 7 Business Marketing Strategies for Global Markets 197 Major volume and market-share advantages might be sought by directing attention to the United States, Europe, and Japan, as well as to the rapidly developing economies of China and India. Source of Advantage: Multidomestic versus Global When downstream activities (those tied directly to the buyer, such as sales and customer service) are important to competitive advantage, a multidomestic pattern of international competition is common. In multidomestic industries, firms pursue separate strategies in each of their foreign markets—competition in each country is essentially independent of competition in other countries (for example, Alcoa in the aluminum industry, Honeywell in the controls industry). Global competition is more common in industries in which upstream and support activities (such as technology development and operations) are vital to competitive advantage. A global industry is one in which a firm’s competitive position in one country is significantly influenced by its position in other countries (for example, Intel in the semiconductor industry, Boeing in the commercial aircraft industry). In his book, Redefining Global Strategy: Crossing Borders in a World Where Differences Still Matter, Pankaj Ghemawat suggests that most types of economic activity that can be conducted either within or across borders are still quite localized.31 He argues that firms must be very careful in deciding between a multidomestic or global strategy because the “internationalization of numerous key economic activities, including fixed capital investment, telephone and Internet traffic, tourism, patents, stock investments, etc., remains at around only 10 percent.” In his view, national borders are still significant and effective international strategies need to take into account both cross-border similarities and critical differences.32 In the current global business environment where security is a major issue, intellectual property rights are in question, there are increased threats of economic protectionism, and a number of countries are reasserting national sovereignty, the decision to follow a purely global strategy must be carefully scrutinized. Coordination and Configuration Further insights into international strategy can be gained by examining two dimensions of competition in the global market: configuration and coordination. Configuration centers on where each activity is performed, including the number of locations. Options range from concentrated (for example, one production plant serving the world) to dispersed (for example, a plant in each country—each with a complete value chain from operations to marketing, sales, and customer service). By concentrating an activity such as production in a central location, firms can gain economies of scale or speed learning. Alternatively, dispersing activities to a number of locations may minimize transportation and storage costs, tailor activities to local market differences, or facilitate learning about market conditions in a country. Coordination refers to how similar activities performed in various countries are coordinated or coupled with each other. If, for example, a firm has three plants—one in the United States, one in England, and one in China—how do the activities in 31 Pankaj Ghemawat, Redefining Global Strategy: Crossing Borders in a World Where Differences Still Matter (Boston: Harvard Business School Press, 2007), pp. 9–32. 32 Ibid., p. 22. 198 Part IV Formulating Business Marketing Strategy FIGURE 7.4 TYPES OF INTERNATIONAL STRATEGY High High Foreign Investment with Extensive Coordination among Subsidiaries Purest Global Strategy Value Activities Coordination of Activities Country-Centered Strategy by Multinationals with a Number of Domestic Firms Operating in Only One Country Export-Based Strategy with Decentralized Marketing Geographically Dispersed Geographically Concentrated Low Configuration of Activities SOURCE: From “Changing Patterns of International Competition” by Michael Porter. Copyright © 1986, by The Regents of the University of California. Reprinted from the California Management Review, Vol. 28, No. 2. By permission of The Regents. these plants relate to one another? Numerous coordination options exist because of the many possible levels of coordination and the many ways an activity can be performed. For example, a firm operating three plants could, at one extreme, allow each plant to operate autonomously (unique production processes, unique products). At the other extreme, the three plants could be closely coordinated, utilizing a common information system and producing products with identical features. Dow Chemical, for example, uses an enterprise software system that allows it to shift purchasing, manufacturing, and distribution functions worldwide in response to changing patterns of supply and demand.33 Types of International Strategy Figure 7.4 portrays some of the possible variations in international strategy. Observe that the purest global strategy concentrates as many activities as possible in one country, 33 Thomas H. Davenport, “Putting the Enterprise into the Enterprise System,” Harvard Business Review, 76 (July–August 1998): pp. 121–131. Chapter 7 Business Marketing Strategies for Global Markets 199 serves the world market from this home base, and closely coordinates activities that must be performed near the buyer (for example, service). Caterpillar, for example, views its battle with the formidable Japanese competitor Komatsu in global terms. As well as using advanced manufacturing systems that allow it to fully exploit the economies of scale from its worldwide sales volume, Caterpillar also carefully coordinates activities in its global dealer network. This integrated global strategy gives Caterpillar a competitive advantage in cost and effectiveness.34 By serving the world market from its home base in the United States and by closely coordinating sales and service with customers around the world, Boeing also aptly illustrates a pure global strategy. Airbus—the European aerospace consortium—is a strong and clever rival that competes aggressively with Boeing for orders at airlines around the world.35 A Global Battle for the PC Market Other interesting global face-offs involve Dell, Inc., versus Lenovo Group, Inc. Dell is now pursuing an integrated global strategy and challenging Lenovo, China’s largest producer in its home market.36 Meanwhile, Lenovo gained worldwide reach when it purchased IBM’s PC division. In turn, Hewlett-Packard remains a formidable rival for both. Other Paths Figure 7.4 illustrates other international strategy patterns. Canon, for example, concentrates manufacturing and support activities in Japan but gives local marketing subsidiaries significant latitude in each region of the world. Thus, Canon pursues an export-based strategy. In contrast, Xerox concentrates some activities and disperses others. Coordination, however, is extremely high: The Xerox brand, marketing approach, and servicing strategy are standardized worldwide. Michael Porter notes: Global strategy has often been characterized as a choice between worldwide standardization and local tailoring, or as the tension between the economic imperative (large-scale efficient facilities) and the political imperative (local content, local production). . . . A firm’s choice of international strategy involves a search for competitive advantage from configuration/coordination throughout the value chain.37 A Strategic Framework Recall that companies may pursue multidomestic strategies or global strategies. The need for a global strategy is determined by the nature of international competition in a particular industry. On the one hand, many industries are multidomestic, and competition takes place on a country-by-country basis with few linkages across operating units (for example, construction and many service offerings). Multidomestic industries do not need a global strategy because the focus should be on developing a series of distinct domestic strategies. 34 Donald V. Fites, “Make Your Dealers Your Partners,” Harvard Business Review 74 (March–April 1996): pp. 84–95. 35 Alex Taylor III, “Blue Skies for Airbus,” Fortune, August 2, 1999, pp. 102–108. 36 Evan Ramstad and Gary McWilliams, “For Dell, Success in China Tells Tale of Maturing Market,” The Wall Street Journal, July 5, 2005, pp. A1, A8. 37 Michael E. Porter, “Changing Patterns of International Competition,” California Management Review 28 (Winter 1986): p. 25. 200 Part IV Formulating Business Marketing Strategy A GENERAL FRAMEWORK FOR GLOBAL STRATEGY FIGURE 7.5 Build on the Foundation of a Unique Competitive Position Emphasize a Consistent Position Strategy across International Markets Global Strategy Establish a Clear Home Base for Each Distinct Business Leverage Product-Line Home Bases at Different Locations Disperse Activities to Extend Home Base Advantages Coordinate and Integrate Dispersed Activities SOURCE: Adapted from Michael E. Porter, “Competing across Locations: Enhancing Competitive Advantage through a Global Strategy,” in Michael E. Porter, ed., On Competition (Boston: Harvard Business School Press, 1998), pp. 309–350. Multidomestic Strategy38 Pankjak Ghemawat provocatively argues that the world is not flat but semiglobalized, and that borders still exist and they matter when it comes to designing strategy. However, instead of focusing exclusively on the physical boundaries, he suggests that managers look at differences between countries and regions in terms of a framework that includes the following dimensions: 1. Cultural 2. Administrative/Political 3. Geographic 4. Economic By analyzing these dimensions, a strategist can illuminate country-to-country differences, understand the liability of “foreignness,” identify and evaluate foreign competitors, and discount market sizes by distance. Following this assessment, the business-to-business manager is better equipped to develop a responsive strategy for each country. Global Strategy For truly global industries, a firm’s position in one country significantly affects its position elsewhere, so it needs a global strategy. Competing across countries through an integrated global strategy requires a series of choices that are highlighted in Figure 7.5. 38 Ghemawat, Redefining Global Strategy, pp. 19–32. Chapter 7 Business Marketing Strategies for Global Markets 201 Global Strategy39 Build on a Unique Competitive Position A business marketing firm should globalize first in those business and product lines where it has unique advantages. To achieve international competitive success, a firm must enjoy a meaningful advantage on either cost or differentiation. To this end, the firm must be able to perform activities at a lower cost than its rivals or perform activities in a unique way that creates customer value and supports a premium price. For example, Denmark’s Novo-Nordisk Group (Novo) is the world’s leading exporter of insulin and industrial enzymes. By pioneering high-purity insulins and advancing insulin delivery technology, Novo achieved a level of differentiation that gave it a strong competitive position in the health-care market in the United States, Europe, and Japan. Emphasize a Consistent Positioning Strategy Rather than modifying the firm’s product and service offerings from country to country, “a global strategy requires a patient, long-term campaign to enter every significant foreign market while maintaining and leveraging the company’s unique strategic positioning.”40 One of the greatest barriers to the success of firms in smaller countries is the perceived need to serve all customer segments and to offer an expanded product assortment to capture the limited market potential. However, by maintaining a consistent position, a firm reinforces its distinctive strategy and keeps its strategic attention focused on the much larger international opportunity. Establish a Clear Home Base for Each Distinct Business Although the location of corporate headquarters is less important and may reflect historical factors, a firm must develop a clear home base for competing in each of its strategically distinct businesses. “The home base for a business is the location where strategy is set, core product and process technology is created and maintained, and a critical mass of sophisticated production and service activities reside.”41 For example, Japan, Honda’s home base for both motorcycles and automobiles, is where 95 percent of its R&D employees are located and all of its core engine research is conducted. For Hewlett-Packard (H-P), the United States hosts 77 percent of the physical space dedicated to manufacturing, R&D, and administration but only 43 percent of H-P’s physical space dedicated to marketing. At H-P’s home base, R&D managers with specialized expertise are designated worldwide experts; they transfer their knowledge either electronically or through periodic visits to subsidiaries around the world. Regional subsidiaries take responsibility for some process-oriented R&D activities and for local marketing. The home base should be located in a country or region with the most favorable access to required resources (inputs) and supporting industries (for example, specialized suppliers). Such a location provides the best environment for capturing productivity and innovation benefits. Honda as well as H-P each benefit from a strong supplier network that supports 39 This section is based on Michael E. Porter, “Competing across Locations: Enhancing Competitive Advantage through a Global Strategy,” in Michael E. Porter, ed., On Competition (Boston: Harvard Business School Press, 1998), pp. 309–350. See also Shaoming Zou and S. Tamer Cavusgil, “The GMS: A Broad Conceptualization of Global Marketing Strategy and Its Effect on Firm Performance,” Journal of Marketing 66 (October 2002): pp. 40–56. 40 Porter, “Competing Across Locations,” p. 331. 41 Ibid., p. 332. 202 Part IV Formulating Business Marketing Strategy each of its principal businesses. The home base should also serve as the central integrating point for activities and have clear worldwide responsibility for the business unit. Leverage Product-Line Home Bases at Different Locations As a firm’s product line broadens and diversifies, different countries may best provide the home bases for some product lines. Responsibility for leading a particular product line should be assigned to the country with the best locational advantages. Each subsidiary, then, specializes in products for which it has the most favorable advantages (for example, specialized suppliers) and serves customers worldwide. For example, H-P locates many product-line home bases outside the United States, such as its line of compact inkjet printers, which is based in Singapore. In turn, Honda has begun to create a product-line home base for Accord station wagons in the United States. The model was conceived, designed, and developed through the joint efforts of Honda’s California and Ohio R&D facilities. Disperse Activities to Extend Home-Base Advantages Although the home base is where core activities are concentrated, other activities can be dispersed to extend the firm’s competitive position. Potential opportunities should be examined in three areas: • Capturing competitive advantages in purchasing. Inputs that are not central to the innovation process, such as raw materials or general-purpose component parts, must be purchased from the most cost-effective location. • Securing or improving market access. By locating selected activities near the market, a firm demonstrates commitment to foreign customers, responds to actual or threatened government mandates, and may be better equipped to tailor offerings to local preferences. For example, Honda has invested more than $2 billion in facilities in the United States. Likewise, a host of firms, like Honeywell, GE, and Intel, have made large investments in China and India. • Selectively tapping competitive advantages at other locations. To improve capabilities in important skills or technologies at home, global competitors can locate selected activities in centers of innovation in other countries. The goal here is to supplement, but not replace, the home base. To illustrate, Honda gains exposure to California’s styling expertise and Germany’s high-performance design competencies through small, local, company-financed design centers that transfer knowledge back to the Japanese home base. Coordinate and Integrate Dispersed Activities Coordination across geographically dispersed locations raises formidable challenges, among them those of language and cultural differences and of aligning the reward systems for individual managers and subsidiaries with the goals of the global enterprise as a whole. However, successful global competitors achieve unified action by 1. Establishing a clear global strategy that is understood by organizational members across countries; Chapter 7 TABLE 7.2 • • • • • • • • • • Business Marketing Strategies for Global Markets 203 KEY FACTORS FOR MANAGING RISK IN EMERGING MARKETS Understand the individual markets: failing to do so is the fastest route to trouble. Use local expertise: there is no substitute for local knowledge. Find a partner: strong local relationships are critical. Understand the culture: taking a consistent approach in all markets ignores cultural differences with wildly different effects. Understand local laws, regulations and ethics: don’t assume they are the same as in your home market. Be cautious and vigilant; pay attention to details, question, and be skeptical. Communicate: open two-way communication is vital, and “gaps” are a crucial cause of misunderstandings. Be present: relationships and understanding do not happen remotely. Be flexible in response to changing conditions: the pace of change can be dramatic. Think long-term: put capacity and resources in place to support the investment over time. SOURCE: From Risk Management in Emerging Markets, p. 6–7. Ernst and Young, 2007. © 2007 EYGM Limited. All rights reserved. Reproduced by permission. 2. Developing information and accounting systems that are consistent on a worldwide basis, thereby facilitating operational coordination; 3. Encouraging personal relationships and the transfer of learning among subsidiary managers across locations; 4. Relying on carefully designed incentive systems that weigh overall contribution to the entire enterprise in addition to subsidiary performance. Managing Risk in Emerging Markets Expansion into new global markets or the establishment of manufacturing activities in low-labor-cost markets is not without risk, and the savvy business marketer will carefully assess the risks associated with working in new, global environments (see Table 7.2). Despite the huge market, low-cost labor, and reduced investment cost, there are still many pitfalls associated with both selling and manufacturing in China. These potential threats include: fragmented markets, limited intellectual property protection, an unstructured legal system, the lack of standardized accounting practices, and heavy investment of government in every facet of business.42 Summary Rapidly developing economies (RDEs), like China and India, present a host of opportunities and a special set of challenges for business-to-business firms. Companies that decisively and intelligently pursue RDE strategies can secure three compelling forms of competitive advantage: significantly lower costs; direct access to the fastest-growing markets; and the capabilities for improving R&D, addressing unmet customer needs, 42 Chia Chia Lin and Jason Lin, “Capitalism in Contemporary China: Globalization Strategies, Opportunities, Threats, and Cultural Issues,” Journal of Global Business Issues, 2 (Winter 2008): pp. 31–40 204 Part IV Formulating Business Marketing Strategy and increasing overall business effectiveness. The migration of sourcing, manufacturing, R&D, and customer service operations from developed economies to RDEs will continue to accelerate in many industry sectors. However, some products and services are better candidates for relocation or outsourcing than others. For example, those with high labor content and large RDE markets represent solid outsourcing candidates, whereas those for which the protection of intellectual property is critical should stay at home. Once a business marketing firm decides to sell its products in a particular country, it must select an entry strategy. The range of options includes exporting, contractual entry modes (for example, licensing), strategic alliances, and joint ventures. A more elaborate form of participation is represented by multinational firms that use multidomestic strategies. Here a separate strategy might be pursued in each country served. The most advanced level of participation in international markets is provided by firms that use a global strategy. Such firms seek competitive advantage by pursuing strategies that are highly interdependent across countries. Global competition tends to be more common in industries in which primary activities, like R&D and manufacturing, are vital to competitive advantage. A global strategy must begin with a unique competitive position that offers a clear competitive advantage. Providing the best odds of global competitive success are businesses and product lines where companies have the most unique advantages. The home base for a business is the location where strategy is set, and the home base for some product lines may be best positioned in other countries. Although core activities are located at the home base, other activities can be dispersed to strengthen the company’s competitive position. Successful global competitors demonstrate special capabilities in coordinating and integrating dispersed activities. Coordination ensures clear positioning and a well-understood concept of global strategy among subsidiary managers across countries. Successful global marketers understand the key risks associated with operating in the global environment, and they take steps to mitigate these risks through their strategic approach to different global markets. To create effective global strategies and capture important market opportunities, business-to-business firms must develop a deep understanding of local markets and the special competitive and environmental forces that will drive performance. Discussion Questions 1. Evaluate this statement: Many business-to-business firms need to fill market gaps at home with new products and services and also follow selected customers to their new locations in rapidly developing economies like India or China. 2. Many observers argue the cost advantage that rapidly developing economies enjoy will evaporate in 5 to 10 years. Agree or disagree? Explain. 3. Describe the characteristics of products and services that would represent poor candidates for outsourcing. 4. In addition to cost advantages, describe the other ways that rapidly developing economies can contribute to competitive advantage. 5. The European aerospace consortium Airbus is a strong competitor to Boeing and is climbing toward its long-stated goal of winning 50 percent Chapter 7 Business Marketing Strategies for Global Markets 205 of the over-100-seat airline market. What criteria would a customer like UPS or British Airways consider in choosing aircraft? What are the critical factors that shape competitive advantage in the aircraft market? 6. A small Michigan-based firm that produces and sells component parts to General Motors, Ford, and DaimlerChrysler wishes to extend market coverage to Europe and Japan. What type of market entry strategy would provide the best fit? 7. A major U.S. electronics firm decides the best approach to a global business strategy is to employ a multidomestic strategy. It will focus its efforts on China. Discuss some of the key threats the firm faces as it enters this market. How could it mitigate some of the risks associated with these threats? 8. A supplier of copper tubing and wire has adopted a multidomestic strategy to enter the eastern European market. What factors should it assess in these countries in order to formulate its marketing strategy in each one. Explain. 9. Why would Hewlett-Packard assign product-line responsibility to a subsidiary located outside the United States? 10. A global strategy begins with a unique competitive position that offers a clear competitive advantage. What steps can a global competitor take to ensure that the strategy is implemented in a consistent way in countries around the world? Internet Exercise 1. General Electric (GE) sells over $5 billion worth of goods and services to Chinese customers in the business market. Go to http:// www.ge.com and first identify the various GE divisions, like Healthcare, that contribute to sales volume and then identify a few products from each division that likely address important needs or priorities in China. CASE Schwinn: Could the Story Have Been Different?43 At its peak, Schwinn had more than 2,000 U.S. employees, produced hundreds of thousands of bicycles in five factories, and held 20 percent of the market. Today, however, Schwinn no longer exists as an operating company. The firm, founded in 1895, declared bankruptcy in 1992 and closed its last factory one year later. The Schwinn name is now owned by a Canada-based firm and all of the bikes are manufactured in Asia. Harold L. Sirkin, a senior vice president at the Boston Consulting Group, argues that Schwinn’s story could have been different. He outlines two alternative pathways that might have provided a happier ending to the Schwinn story. Alternative Reality One: Aim High Under this scenario, Schwinn decided to center on midrange and premium segments of the market, leaving low-end bicycles for competitors. However, the firm determined that it could substantially reduce costs by turning to low-cost partners in rapidly developing economies for labor-intensive parts. Schwinn interviewed hundreds of potential suppliers and locked the best ones into long-term contracts. Schwinn then reconfigured its operations to perform final assembly and quality inspection in the United States. Still, the changes forced Schwinn to make some painful choices—nearly 30 percent of the workforce was laid off. However, such moves allowed Schwinn to produce bikes at half the previous cost, maintain a significant position in the midrange bicycle market, and leverage its product design capabilities to build a strong position for its brand in the high-end market. As a result, Schwinn is extremely competitive in the U.S. market and is a major exporter of premium bikes to China and Europe. Because of this growth, Schwinn now employs twice as many people in the United States as it did before outsourcing began. Alternative Reality Two: If You Can’t Beat Them, Join Them Schwinn went on the offensive and moved as quickly as possible to open its own factory in China. By bringing its own manufacturing techniques and by training employees in China, Schwinn was able to achieve high quality and a much lower cost. However, the decision meant that 70 percent of Schwinn’s U.S. workers would lose their jobs. But Schwinn kept expanding its China operations and soon started selling bicycles in the Chinese market—not only at the low end but also to the high-end, luxury segment—leveraging its brand name. Schwinn then extended its global operations and reach by adding new facilities in eastern Europe and Brazil. The company has sold over 500,000 bikes in new markets and now has more employees in the United States than it did before deciding to expand into international markets. 43 Harold L. Sirkin, “Don’t Be a Schwinn,” BCG/Perspectives, The Boston Consulting Group, Inc., January 2005, accessed at http://www.bcg.com. 206 206 Chapter 7 Business Marketing Strategies for Global Markets 207 Discussion Question 1. By facing fierce competition from low-cost rivals, many business-to-business firms in the United States and Europe face a situation today similar to Schwinn’s. What lessons can they draw from the Schwinn story? How can they strengthen their competitive position? CHAPTER 8 Managing Products for Business Markets By providing a solution for customers, the product is the central force of business marketing strategy. The firm’s ability to put together a line of products and services that provide superior value to customers is the heart of business marketing management. After reading this chapter, you will understand: 1. how to build a strong business-to-business brand. 2. the strategic importance of providing competitively superior value to customers. 3. the various types of industrial product lines and the value of product positioning. 4. a strategic approach for managing products across the stages of the technology adoption life cycle. 208 Chapter 8 Managing Products for Business Markets 209 To spur growth at General Electric, CEO Jeffrey Immelt told GE’s 11 business unit managers to each take 60 days and return with five ideas for growth that would generate at least $10 million in sales within three years.1 Of the 55 ideas proposed, 35 were funded, ranging from wind-powered energy systems to sophisticated airport security systems using medical scanning technology. A business marketer’s marketplace identity is established through its brand and through the products and services it offers. For example, General Electric’s new branding campaign—“Ecomagination”—signals to the market that the firm is very serious about its responsibilities to the environment and is offering solutions such as wind, energy, and water filtration equipment as well as clean-coal services.2 Because brands constitute one of the most valuable intangible assets that firms possess, branding has emerged as a priority to marketing executives, CEOs, and the financial community. Product management is directly linked to market analysis and market selection. Products are developed to fit the needs of the market and are modified as those needs change. Drawing on such tools of demand analysis as business market segmentation and market potential forecasting, the marketer evaluates opportunities and selects profitable market segments, thus determining the direction of product policy. Product policy cannot be separated from market selection decisions. In evaluating potential product/market fits, a firm must evaluate new market opportunities, determine the number and aggressiveness of competitors, and gauge its own strengths and weaknesses. The marketing function assumes a lead role in transforming an organization’s distinctive skills and resources into products and services that enjoy positional advantages in the market.3 This chapter first explores the nature of the brand-building process and the way in which a strong brand can sharpen the focus and energize the performance of the firm. Second, it examines product quality and value from the customer’s perspective and directly links them to business marketing strategy. Third, because industrial products can assume several forms, the chapter describes industrial product-line options, while offering an approach for positioning and managing products in high-technology markets. Building a Strong B2B Brand Although consumer packaged-goods companies like Procter & Gamble (P&G), Coca-Cola, and Nestle have excelled by developing a wealth of enduring and highly profitable brands, some of the most valuable and powerful brands belong to businessto-business firms: IBM, Microsoft, General Electric, Intel, Hewlett-Packard, Cisco, Google, Oracle, Canon, Siemens, Caterpillar, and a host of others. For most business marketers, the company name is the brand, so the key questions become: “What do you want your company name to stand for? and What do you want it to mean in the mind of the customer?”4 1Bob Lamons, The Case for B2B Branding (Mason, OH: Thomson Higher Education, 2005), pp. 142–144. 2Regis McKenna, Relationship Marketing (Reading, MA: Addison-Wesley, 1991), p. 7. 3Rajan Varadarajan and Satish Jayachandran, “Marketing Strategy: An Assessment of the State of the Field and Outlook,” Journal of the Academy of Marketing Science 27 (Spring 1999): pp. 120–143. 4Frederick E. Webster Jr. and Kevin Lane Keller, “A Roadmap for Branding in Industrial Markets,” Journal of Brand Management 12 (May 2004): p. 389. 210 Part IV Formulating Business Marketing Strategy FIGURE 8.1 CUSTOMER-BASED BRAND EQUITY PYRAMID Intense, active loyalty Consumerbrand resonance Consumer judgments Positive, accessible reactions Consumer feelings Brand performance Brand imagery Strong, favorable and unique brand associations Brand salience Deep, broad brand awareness SOURCE: Kevin Lane Keller, “Building Customer-Based Brand Equity,” Marketing Management 10 (July/August 2001): p. 19. Copyright © 2001 American Marketing Association. All rights reserved. Reproduced by permission. David Aaker says, “Brand equity is a set of brand assets and liabilities linked to a brand, its name, and symbol that add to or subtract from the value provided by a product or service and/or to that firm’s customers.”5 As we will explore, the assets and liabilities that impact brand equity include brand loyalty, name awareness, perceived quality and other brand associations, and proprietary brand assets (for example, patents). A brand, then, is a name, sign, symbol, or logo that identifies the products and services of one firm and differentiates them from competitors. Providing a rich and incisive perspective, Kevin Lane Keller defines customerbased brand equity (CBBE) as the differential effect that customers’ brand knowledge has on their response to marketing activities and programs for that brand.6 The basic premise of his CBBE model is that the power of a brand lies in “what consumers have learned, felt, seen, and heard about the brand over time.”7 So, the power of a brand is represented by all the thoughts, feelings, perceptions, images, and experiences that become linked to the brand in the minds of customers. Brand-Building Steps8 The CBBE model lays out a series of four steps for building a strong brand (see Fig ure 8.1, right side): (1) develop deep brand awareness or a brand identity; (2) establish the meaning of the brand through unique brand associations (that is, points of difference); (3) elicit a positive brand response from customers through marketing programs; and (4) build brand relationships with customers, characterized by intense loyalty. Providing the foundation for successful brand management is the set of 5David Aaker, Managing Brand Equity (New York: The Free Press, 1991), p. 15. 6Kevin Lane Keller, Strategic Brand Management (3rd ed., Upper Saddle River, NJ: Prentice Hall, 2007). 7Webster and Keller, “A Roadmap for Branding,” p. 15. 8This section is based on Kevin Lane Keller, “Building Customer-Based Brand Equity,” Marketing Management 10 (July/ August 2001): pp. 15–19. Chapter 8 Managing Products for Business Markets 211 brand-building blocks (see Figure 8.1, left side) aligned with the branding ladder— salience, performance, imagery, judgments, feelings, and resonance. Brand Identity To achieve the right identity for a brand, the business marketer must create brand salience with customers. Brand salience is tied directly to brand awareness: How often is the brand evoked in different situations? What type of cues or reminders does a customer need to recognize a brand? Brand awareness refers to the customer’s ability to recall or recognize a brand under different conditions. The goal here is to ensure that customers understand the particular product or service category where the brand competes by creating clear connections to the specific products or services that are solely under the brand name. Brand Meaning Brand positioning involves establishing unique brand associations in the minds of customers to differentiate the brand and establish competitive superiority.9 Although a multitude of different types of brand associations are possible, brand meaning can be captured by examining two broad categories: (1) brand performance—the way in which the product or service meets customers’ more functional needs (for example, quality, price, styling, and service effectiveness) and (2) brand imagery—the ways in which the brand attempts to meet customers’ more abstract psychological or social needs. Brand positioning should incorporate both points of parity and points of difference in the customer value proposition (see Chapter 4). “Points of difference are strong, favorable, unique brand associations that drive customers’ behavior; points of parity are those associations where the brand ‘breaks even’ with competitors and negates their intended points of difference.”10 Strong business-to-business brands like Cisco, IBM, Google, and FedEx have clearly established strong, favorable (that is, valuable to customers), and unique brand associations with customers. Brand Response As a branding strategy is implemented, special attention should be directed to how customers react to the brand and the associated marketing activities. Four types of customer judgments are particularly vital to the creation of a strong brand (in ascending order of importance): 1. Quality—the customer’s attitudes toward a brand’s perceived quality as well as their perceptions of value and satisfaction; 2. Credibility—the extent to which the brand as a whole is perceived by customers as credible in terms of expertise, trustworthiness, and likeability; 3. Consideration set—the degree to which customers find the brand to be an appropriate option worthy of serious consideration; 4. Superiority—the extent to which customers believe that the brand offers unique advantages over competitors’ brands. Feelings relate to the customers’ emotional reaction to the brand and include numerous types that have been tied to brand building, including warmth, fun, 9Kevin Lane Keller, Brian Sternthal, and Alice Tybout, “Three Questions You Need to Ask About Your Brand,” Harvard Business Review 80 (September 2002): pp. 80–89. 10Webster and Keller, “A Roadmap for Branding,” p. 390. 212 Part IV Formulating Business Marketing Strategy excitement, and security. For example, Apple’s brand might elicit feelings of excitement (customers are energized by the brand and believe that the brand is cool); IBM or FedEx may evoke feelings of security (the brand produces a feeling of comfort or self-assurance); and Cisco’s branding campaign, “Welcome to the Human Network,” might elicit warmth (the brand makes customers feel peaceful). Cisco’s vice president–corporate marketing, Marilyn Mersereau, says, “Instead of being a product player with the ‘Powered by Cisco’ campaign, we’re trying to position Cisco to be a platform for your life experience,” educating customers about the ways Cisco makes it easier for people to connect with one another via the Web.11 Forging Brand Relationships An examination of the level of personal identification and the nature of the relationship a customer has formed with the brand is the final step in the brand-building process. Brand resonance represents the strength of the psychological bond that a customer has with a brand and the degree to which this connection translates into loyalty, attachment, and active engagement with the brand. Keller observes, “Brand resonance reflects a completely harmonious relationship between customers and the brand. . . . The strongest brands will be the ones to which those consumers become so attached that they, in effect, become evangelists and actively seek means to interact with the brand and share their experiences with others.”12 A Systems Model for Managing a Brand To build and properly manage brand equity, Kevin Lane Keller and Donald R. Lehman provide an integrative model that can be used to isolate key dimensions of the brand management process.13 (See Figure 8.2.) Company Actions A controllable element for the business marketer in creating brand value concerns the type and amount of marketing expenditures (for example, dollars spent on advertising or channel partner development) as well as the clarity, distinctiveness, and consistency of the marketing strategy, over time and across activities. Strong brands receive proper R&D and marketing support and that support is sustained over time. What Customers Think and Feel As we have seen, the “brand ladder” follows an order from awareness and brand associations to attachment and intense, active loyalty. Of course, the actions of competitors as well as environmental conditions can influence how customers feel about a brand (for example, Microsoft poses a challenge to Intuit, UPS challenges FedEx, and Apple’s iPhone poses a threat to Research in Motion’s BlackBerry). Strong brands stay relevant and excel at providing the benefits that matter the most to customers.14 What Customers Do The primary payoff from positive customer thoughts and feelings is reflected in the purchases they make. Strong brands provide a host of 11“B to B’s Best Brands: Cisco,” B to B’s Best, 2007, accessed at http://www.btobonline.com on July 15, 2008. 12Keller, “Building Customer Brand-Based Equity,” p. 19. 13Kevin Lane Keller and Donald R. Lehman, “Brands and Branding: Research Findings and Future Priorities,” Marketing Science 25 (November–December 2006): pp. 740–759. 14Kevin Lane Keller, “The Brand Report Card,” Harvard Business Review 78 (January–February 2000): pp. 147–157. Chapter 8 FIGURE 8.2 Managing Products for Business Markets 213 A SYSTEMS MODEL OF BRAND ANTECEDENTS AND CONSEQUENCES Company actions Strategy Direction Programs Specifics: type, budget Quality Quality Partners’ actions (channels, employees) What customers think and feel about a brand Competitor’s actions Industry/environmental conditions Awareness Associations Attitude Attachment Activity Satisfaction What customers do about a brand Financial market impact SOURCE: Reprinted by permission, Kevin Lane Keller and Donald R. Lehman, “Brands and Branding: Research Findings and Future Priorities,” Marketing Science 25 (November/December 2006): p. 753. Copyright © 2006 INFORMS. Institute for Operations Research and the Management Sciences (INFORMS), 7240 Parkway Drive, Suite 300, Hanover, MD 21076 USA. 214 Part IV Formulating Business Marketing Strategy B2B TOP PERFORMERS Corporate Brand Personality Traits of a Successful 21st-Century Business While a product brand personality relates to consumer and user imagery for a specific product, a corporate brand personality centers on the human characteristics or traits of the employees of the corporation as a whole. So, a corporate brand personality is much broader and reflects the values, words, and actions of organizational members, individually and collectively. Kevin Lane Keller and Keith Richey assert that the corporate brand personality traits of a successful 21st -century business can be defined on three dimensions, thereby guiding employees and influencing how the company will be perceived by customers and key stakeholders: • The “heart” of the company consists of two traits: passionate and compassionate. The firm must be passionate about serving customers and demonstrate compassion for employees, suppliers, partners, and members of the communities in which it operates. (Through its customer-centric focus and support of numerous charitable initiatives, Southwest Airlines demonstrates these traits.) • The “mind” of the company consists of two traits: creative and disciplined. A successful firm must develop creative solutions for its customers and display a disciplined approach that is reflected in consistent actions across the organization. (Based on their success in new product development and superior strategy execution, Apple and Intel demonstrate these traits.) • The “body” of the company includes two traits: agile and collaborative. The successful firm must have the agility to react quickly to changing market requirements and emphasize a collaborative approach that ensures effective working relationships across functions and with important stakeholders. (By responding quickly to market changes and pursuing relationship marketing strategies that are embraced by customers, channel partners, and alliance partners, Cisco aptly demonstrates these traits.) SOURCE: Kevin Lane Keller and Keith Richey, “The Importance of Corporate Brand Personality Traits to a Successful 21st Century Business,” The Journal of Brand Management 14 (September–November 2006): pp. 74–81. Reprinted by permission from Macmillan Publishers Ltd. Copyright 2006. possible benefits to a firm such as greater customer loyalty, less vulnerability to competitive actions, higher profit margins, and greater cooperation and support from channel partners. How Financial Markets React A host of business-to-business companies have launched brand-building initiatives, but do such investments generate positive returns? Some recent research on the brand attitude of buyers in evaluating computerrelated firms provides some answers.15 Brand attitude is a component and indicator of brand equity. Brand attitude is defined as the percentage of organizational buyers who have a positive image of a company minus those with a negative opinion. This study found that changes in brand attitude are associated with stock market performance and tend to lead accounting financial performance (that is, an increase in brand attitude will be reflected in improved financial performance three to six months later). 15David A. Aaker and Robert Jacobson, “The Value Relevance of Brand Attitude in High-Technology Markets,” Journal of Marketing Research 38 (November 2001): pp. 485–493. Chapter 8 Managing Products for Business Markets 215 In short, the research demonstrates that investments in building brand attitude for high-technology firms do indeed pay off and increase the firm’s value. In another intriguing study, Thomas J. Madden, Frank Fehle, and Susan Fournier provide empirical evidence of the link between branding and shareholder value creation.16 They found that a portfolio of brands identified as strong by the Interbrand/ Business Week valuation method displays significant performance advantages compared to the overall market. “Firms that have developed strong brands create value for their shareholders by yielding returns that are greater in magnitude than a relevant market benchmark, and perhaps more important, do so with less risk.”17 Product Quality and Customer Value Rising customer expectations make product quality and customer value important strategic priorities. On a global scale, many international companies insist that suppliers, as a prerequisite for negotiations, meet quality standards set out by the Geneva-based International Standards Organization (ISO). These quality requirements, referred to as ISO-9000 standards, were developed for the European Community but have gained a global following.18 Certification requires a supplier to thoroughly document its quality-assurance program. The certification program is becoming a seal of approval to compete for business not only overseas but also in the United States. For instance, the Department of Defense employs ISO standards in its contract guidelines. Although Japanese firms continue to set the pace in the application of sophisticated quality-control procedures in manufacturing, companies such as Kodak, AT&T, Xerox, Ford, HewlettPackard, Intel, GE, and others have made significant strides. The quest for improved product quality touches the entire supply chain as these and other companies demand improved product quality from their suppliers, large and small. For example, GE has an organization-wide goal of achieving Six Sigma quality, meaning that a product would have a defect level of no more than 3.4 parts per million. Using the Six Sigma approach, GE measures every process, identifies the variables that lead to defects, and takes steps to eliminate them. GE also works directly to assist suppliers in using the approach. Overall, GE reports that Six Sigma has produced striking results—cost savings in the billions and fundamental improvements in product and service quality. Recently, GE has centered its Six Sigma efforts on functions that “teach customers,” such as marketing and sales.19 Meaning of Quality The quality movement has passed through several stages.20 Stage one centered on conformance to standards or success in meeting specifications. But conformance quality or zero defects do not satisfy a customer if the product embodies the wrong features. 16Thomas J. Madden, Frank Fehle, and Susan Fournier, “Brands Matter: An Empirical Demonstration of the Creation of Shareholder Value Through Branding,” Journal of the Academy of Marketing Science 34 (2, 2006): pp. 224–235. 17Ibid., pp. 232–233. 18Wade Ferguson, “Impact of ISO 9000 Series Standards on Industrial Marketing,” Industrial Marketing Management 25 (July 1996): pp. 325–310. 19Erin White, “Rethinking the Quality-Improvement Program,” The Wall Street Journal, September 19, 2005, p. B3. 20Bradley T. Gale, Managing Customer Value: Creating Quality and Service That Customers Can See (New York: The Free Press, 1994), pp. 25–30. 216 Part IV Formulating Business Marketing Strategy Stage two emphasized that quality was more than a technical specialty and that pursuing it should drive the core processes of the entire business. Particular emphasis was given to total quality management and measuring customer satisfaction. However, customers choose a particular product over competing offerings because they perceive it as providing superior value—the product’s price, performance, and service render it the most attractive alternative. Stage three, then, examines a firm’s quality performance relative to competitors and examines customer perceptions of the value of competing products. The focus here is on market-perceived quality and value versus that of competitors. Moreover, attention shifts from zero defects in products to zero defections of customers (that is, customer loyalty). Merely satisfying customers who have the freedom to make choices is not enough to keep them loyal.21 Meaning of Customer Value Strategy experts Dwight Gertz and Joõa Baptista suggest that “a company’s product or service is competitively superior if, at price equality with competing products, target segments always choose it. Thus, value is defined in terms of consumer choice in a competitive context.”22 In turn, the value equation includes a vital service component. For the service component, business marketing strategists must “recognize that specifications aren’t just set by a manufacturer who tells the customer what to expect; instead, consumers also may participate in setting specifications.” Frontline sales and service personnel add value to the product offering and the consumption experience by meeting or, indeed, exceeding the customer’s service expectations.23 Customer value, then, represents a “business customer’s overall assessment of a relationship with a supplier based on perceptions of benefits received and sacrifices made.”24 Benefits Customer benefits take two forms (Figure 8.3): 1. Core benefits—the core requirements (for example specified product quality) for a relationship that suppliers must fully meet to be included in the customer’s consideration set; 2. Add-on benefits—attributes that differentiate suppliers, go beyond the basic denominator provided by all qualified vendors, and create added value in a buyer-seller relationship (for example, value-added customer service). Sacrifices Consistent with the total cost perspective that business customers emphasize (Chapter 2), sacrifices include (1) the purchase price, (2) acquisition costs (for example, ordering and delivery costs), and (3) operations costs (for example, defectfree incoming shipments of component parts reduces operations costs). 21Thomas O. Jones and W. Earl Sasser, “Why Satisfied Customers Defect,” Harvard Business Review 73 (November– December 1995): pp. 88–99; and Richard L. Oliver, “Whence Customer Loyalty,” Journal of Marketing 63 (Special Issue 1999): pp. 33–44. 22Dwight L. Gertz and João P. A. Baptista, Grow to Be Great: Breaking the Downsizing Cycle (New York: The Free Press, 1995), p. 128. 23C. K. Prahalad and M. S. Krishnan, “The New Meaning of Quality in the Information Age,” Harvard Business Review 77 (September–October 1999): pp. 109–112. See also, C. K. Prahalad and Venkat Ramaswamy, The Future of Competition: Co-Creating Unique Value with Customers (Boston: Harvard Business School Press, 2004). 24Ajay Menon, Christian Homburg, and Nikolas Beutin, “Understanding Customer Value in Business-to-Business Relationships,” Journal of Business-to-Business Marketing 12 (2, 2005): p. 5. See also, Wolfgang Ulaga and Andreas Eggert, “Value-Based Differentiation in Business Relationships: Gaining and Sustaining Key Supplier Status,” Journal of Marketing 70 (January 2006): pp. 119–136. Chapter 8 FIGURE 8.3 Managing Products for Business Markets 217 WHAT VALUE MEANS TO BUSINESS CUSTOMERS Core Benefits Add-on Customer Value Price Sacrifices Acquisition Costs Operations Costs SOURCE: Adapted from Ajay Menon, Christian Homburg, and Nikolas Beutin, “Understanding Customer Value,” Journal of Business-to-Business Marketing 12 (2, 2005): pp. 4–7. What Matters Most? Based on a large study of nearly 1,000 purchasing managers across a wide variety of product categories in the United States and Germany, Ajay Menon, Christian Homburg, and Nikolas Beutin uncovered some rich insights into customer value in business-to-business relationships.25 Add-on Benefits First, the research demonstrates that add-on benefits more strongly influence customer value than do core benefits. Why? All qualified suppliers perform well on core benefits, so add-on benefits tend to be the differentiator for customer value as customers choose among competing offerings. Therefore, business marketers can use value-added services or joint working relationships that influence add-on benefits to strengthen customer relationships. For example, a leading manufacturer of tires for earthmoving equipment offers free consulting services that help customers design maintenance procedures that yield significant cost savings.26 Trust Second, the study reinforces the vital role of trust in a business relationship (see Chapter 4), demonstrating, in fact, that trust has a stronger impact on core benefits than product characteristics. Reducing Customer’s Costs Third, the results highlight the importance of marketing strategies that are designed to assist the customer in reducing operations costs. The research team observes: Ensuring on-time delivery of components and raw materials, getting involved in the customer firm’s manufacturing and R&D strategy-making processes, and deploying resources needed to ensure a smooth relationship with the customer will help reduce the customer’s operations costs.27 25Menon, Homburg, and Beutin, “Understanding Customer Value,” pp. 1–33. 26Das Narayandas, “Building Loyalty in Business Markets,” Harvard Business Review 83 (September–October 2005): p. 134. 27Menon, Homburg, and Beutin, “Understanding Customer Value,” p. 25. 218 Part IV Formulating Business Marketing Strategy By pursuing such initiatives, the business marketer does not have to rely solely on price to demonstrate and deliver value to the customer. Product Support Strategy: The Service Connection The marketing function must ensure that every part of the organization focuses on delivering superior value to customers. Business marketing programs involve a number of critical components that customers carefully evaluate: tangible products, service support, and ongoing information services both before and after the sale. To provide value and to successfully implement these programs, the business marketing firm must carefully coordinate activities among personnel in product management, sales, and service.28 For example, to customize a product and delivery schedule for an important customer requires close coordination among product, logistics, and sales personnel. Moreover, some customer accounts might require special field-engineering, installation, or equipment support, thereby increasing the required coordination between sales and service units. Post-purchase service is especially important to buyers in many industrial product categories ranging from computers and machine tools to custom-designed component parts. Responsibility for service support, however, is often diffused throughout various departments, such as applications engineering, customer relations, or service administration. Significant benefits accrue to the business marketer who carefully manages and coordinates product, sales, and service connections to maximize customer value. Product Policy Product policy involves the set of all decisions concerning the products and services that the company offers. Through product policy, a business marketing firm attempts to satisfy customer needs and to build a sustainable competitive advantage by capitalizing on its core competencies. This section explores the types of industrial product lines and the importance of anchoring product-management decisions on an accurate definition of the product market. A framework is also provided for assessing product opportunities on a global scale. Types of Product Lines Defined Because product lines of industrial firms differ from those of consumer firms, classification is useful. Industrial product lines can be categorized into four types29: 1. Proprietary or catalog products. These items are offered only in certain configurations and produced in anticipation of orders. Product-line decisions concern adding, deleting, or repositioning products in the line. 2. Custom-built products. These items are offered as a set of basic units, with numerous accessories and options. For example, NCR offers a line of retail 28Frank V. Cespedes, Concurrent Marketing: Integrating Product, Sales, and Service (Boston: Harvard Business School Press, 1995), pp. 58–85. 29Benson P. Shapiro, Industrial Product Policy: Managing the Existing Product Line (Cambridge, MA: Marketing Science Institute, 1977), pp. 37–39. Chapter 8 Managing Products for Business Markets 219 workstations used by large customers like Wal-Mart and 7-Eleven stores as well as by smaller businesses. The basic workstation can be expanded to connect to scanners, check readers, electronic payment devices, and other accessories to meet a business’s particular needs. The firm’s wide array of products provides retailers with an end-to-end solution, from data warehousing to the point-ofservice workstation at checkout. The marketer offers the organizational buyer a set of building blocks. Product-line decisions center on offering the proper mix of options and accessories. 3. Custom-designed products. These items are created to meet the needs of one or a small group of customers. Sometimes the product is a unique unit, such as a power plant or a specific machine tool. In addition, some items produced in relatively large quantities, such as an aircraft model, may fall into this category. The product line is described in terms of the company’s capability, and the consumer buys that capability. Ultimately, this capability is transformed into a finished good. For example, after canvassing airlines around the world, Airbus detected enough interest in a super jumbo jet to proceed with development.30 4. Industrial services. Rather than an actual product, the buyer is purchasing a company’s capability in an area such as maintenance, technical service, or management consulting. (Special attention is given to services marketing in Chapter 10.) All types of business marketing firms confront product policy decisions, whether they offer physical products, pure services (no physical product), or a product-service combination.31 Each product situation presents unique problems and opportunities for the business marketer; each draws on a unique capability. Product strategy rests on the intelligent use of corporate capability. Defining the Product Market Accurately defining the product market is fundamental to sound product-policy decisions.32 Careful attention must be given to the alternative ways to satisfy customer needs. For example, many different products could provide competition for personal computers. Application-specific products, such as enhanced pocket pagers and smart phones that send e-mail and connect to the Web, are potential competitors. A wide array of information appliances that provide easy access to the Internet also pose a threat. In such an environment, Regis McKenna maintains, managers “must look for opportunities in—and expect competition from—every possible direction. A company with a narrow product concept will move through the market with blinders on, and it is sure to run into trouble.”33 By excluding products and technology that compete for the same end-user needs, the product strategist can quickly become out of touch with the market. Both customer needs and the ways of satisfying those needs change. 30Alex Taylor III, “Blue Skies for Airbus,” Fortune, April 1, 1999, pp. 102–108. 31Albert L. Page and Michael Siemplenski, “Product-Systems Marketing,” Industrial Marketing Management 12 (April 1983): pp. 89–99. 32For a related discussion on competitive analysis, see Beth A. Walker, Dimitri Kapelianis, and Michael D. Hutt, “Competitive Cognition,” MIT Sloan Management Review 46 (Summer 2005): pp. 10–12. 33McKenna, Relationship Marketing, p. 184. 220 Part IV Formulating Business Marketing Strategy Product Market A product market establishes the distinct arena in which the business marketer competes. Four dimensions of a market definition are strategically relevant: 1. Customer function dimension. This involves the benefits that are provided to satisfy the needs of organizational buyers (for example, mobile messaging). 2. Technological dimension. There are alternative ways a particular function can be performed (for example, cell phone, pager, notebook computer). 3. Customer segment dimension. Customer groups have distinct needs that must be served (for example, sales representatives, physicians, international travelers). 4. Value-added system dimension. Competitors serving the market can operate along a sequence of stages.34 The value-added system for wireless communication includes equipment providers, such as Nokia and Motorola, and service providers, like Verizon and AT&T. Analysis of the value-added system may indicate potential opportunities or threats from changes in the system (for example, potential alliances between equipment and service providers). Planning for Today and Tomorrow Competition to satisfy the customer’s need exists at the technology level as well as at the supplier or brand level. By establishing accurate product-market boundaries, the product strategist is better equipped to identify customer needs, the benefits sought by the market segment, and the turbulent nature of competition at both the technology and supplier or brand levels. Derek Abell offers these valuable strategy insights: • Planning for today requires a clear, precise definition of the business—a delineation of target customer segments, customer functions, and the business approach to be taken; planning for tomorrow is concerned with how the business should be redefined for the future. • Planning for today focuses on shaping up the business to meet the needs of today’s customers with excellence. It involves identifying factors that are critical to success and smothering them with attention; planning for tomorrow can entail reshaping the business to compete more effectively in the future.35 Seeing What’s Next Strategy experts also argue provocatively that many firms are overlooking three important customer groups that may present the greatest opportunity for explosive growth36: • Nonconsumers who may lack the specialized skills, training, or resources to purchase the product or service; • Undershot customers for whom existing products are not good enough; • Overshot customers for whom existing products provide more performance than they can use. 34George S. Day, Strategic Market Planning: The Pursuit of Competitive Advantage (St. Paul, MN: West, 1984), p. 73. 35Derek F. Abell, “Competing Today While Preparing for Tomorrow,” Sloan Management Review 40 (Spring 1999): p. 74. 36Clayton M. Christensen, Scott D. Anthony, and Erik A. Roth, Seeing What’s Next (Boston: Harvard Business School Press, 2004), p. 5. Chapter 8 Managing Products for Business Markets 221 B2B TOP PERFORMERS BASF: Using Services to Build a Strong Brand BASF AG, headquartered in Germany, is the world’s largest chemical company, with global sales over $33 billion and North American sales of $8 billion. Consistently ranked as one of Fortune’s most admired global companies, the firm competes in what many would describe as a commodity business. Rather than pursue a low-total-cost strategy and compete on price, BASF decided to transform itself into an innovative service-oriented company. Services, like R&D support or onsite field services, are hard for rivals to duplicate and when well executed, provide the ultimate differentiation strategy. To communicate its value proposition to customers, the firm launched its advertising campaign with the familiar tag line: “We don’t make a lot of products you buy. We make a lot of the products you buy better.” A senior executive at BASF’s ad agency, Tony Graetzer, describes the rationale for this campaign, which has been recognized with numerous awards: “Companies are frequently viewed as tied on the quality of their products, but they are never viewed as tied on the quality of their services.” Winning companies provide superior service. By emphasizing how it helps make its customers’ products better and delivering on its promises, the BASF brand has become synonymous with customer partnerships and technology leadership. SOURCE: Bob Lamons, The Case for B2B Branding (Mason, Ohio: Thomson, 2005), pp. 91–94. Planning Industrial Product Strategy Formulating a strategic marketing plan for an existing product line is the most vital part of a company’s marketing planning efforts. Having identified a product market, attention now turns to planning product strategy. Product-positioning analysis provides a useful tool for charting the strategy course. Product Positioning Once the product market is defined, a strong competitive position for the product must be secured. Product positioning represents the place that a product occupies in a particular market; it is found by measuring organizational buyers’ perceptions and preferences for a product in relation to its competitors. Because organizational buyers perceive products as bundles of attributes (for example, quality, service), the product strategist should examine the attributes that assume a central role in buying decisions. The Process37 Observe from Figure 8.4 that the positioning process begins by identifying the relevant set of competing products (Step 1) and defining those attributes that are determinant (Step 2)—attributes that customers use to differentiate among the alternatives 37This section is based on Harper W. Boyd Jr., Orville C. Walker Jr., and Jean-Claude Larréché, Marketing Management: A Strategic Approach with a Global Orientation (Chicago: Irwin/McGraw-Hill, 1998), pp. 190–200. 222 Part IV Formulating Business Marketing Strategy FIGURE 8.4 STEPS IN THE PRODUCT-POSITIONING PROCESS 1. Identify the relevant set of competitive products 2. Identify the set of determinant attributes that customers use to differentiate among options and determine the preferred choice 3. Collect information from a sample of existing and potential customers concerning their ratings of each product on the determinant attributes 4. Determine the product’s current position versus competing offerings for each market segment 5. Examine the fit between preferences of market segments and current position of product 6. Select Positioning or Repositioning Strategy SOURCE: Adapted with modifications from Harper W. Boyd Jr., Orville C. Walker Jr., and Jean-Claude Larréché, Marketing Management: A Strategic Approach with a Global Orientation (Chicago: Irwin/McGraw-Hill, 1998), p. 197. and that are important to them in determining which brand they prefer. In short, then, determinant attributes are choice criteria that are both important and differentiating. Of course, some attributes are important to organizational buyers, but they may not be differentiating. For example, safety might be an important attribute in the heavy-duty truck market, but business market customers may consider the competing products offered by Navistar, Volvo, and Mack Trucks as quite comparable on this dimension. Durability, reliability, and fuel economy might constitute the determinant attributes. Step 3 involves collecting information from a sample of existing and potential customers concerning how they perceive the various options on each of the determinant attributes. The sample should include buyers (particularly buying influentials) from organizations that represent the full array of market segments the product strategist wishes to serve. After examining the product’s current position versus competing offerings (Step 4), the analyst can isolate (1) the competitive strength of the product in different segments and (2) the opportunities for securing a differentiated position in a particular target segment (Step 5). Isolating Strategy Opportunities Step 6 involves the selection of the positioning or repositioning strategy. Here the product manager can evaluate particular strategy options. First, for some attributes, the product manager may wish to (1) pursue a strategy to increase the importance of an attribute to customers and (2) increase the difference between the competition’s and the firm’s products. For example, the importance of an attribute such as customer training Chapter 8 Managing Products for Business Markets 223 might be elevated through marketing communications emphasizing how the potential buyer can increase its efficiency and employee performance through the firm’s training. If successful, such efforts might move customer training from an important attribute to a determinant attribute in the eyes of customers. Second, if the firm’s performance on a determinant product attribute is truly higher than that of competitors—but the market perceives that other alternatives enjoy an edge—marketing communications can be developed to bring perceptions in line with reality. Third, the competitive standing of a product can be advanced by improving the firm’s level of performance on determinant attributes that organizational buyers emphasize. Product Positioning Illustrated 38 This product positioning approach was successfully applied to a capital equipment product at a major corporation. The product that provided the focus of the analysis is sold in three sizes to two market segments: end users and consulting engineers. Marketing research identified 15 attributes, including reliability, service support, company reputation, and ease of maintenance. A New Strategy The research found that the firm’s brand enjoyed an outstanding rating on product reliability and service support. Both attributes were generally determinant for the company against most competitors. To reinforce the importance of both attributes, management decided to offer an enhanced warranty program. Both end users and consulting engineers view warranties as important but not a point of differentiation across competing brands. Management surmised, however, that by establishing a new warranty standard for the industry, the attribute could become determinant, adding to the brand’s leverage over competitors. In addition, management felt that the new warranty program might also benefit the brand’s reputation on other attributes such as reliability and company reputation. Better Targeting The study also provided some surprises. Price was not nearly as important to organizational buyers as management had initially believed. This suggested that there were opportunities to increase revenue through product differentiation and service support. Likewise, the research found that the firm’s brand dominated all competitors in the large- and medium-sized products, but not in the small-sized products. This particular product had an especially weak competitive position in the consulting engineer segment. Special service support strategies were developed to strengthen the product’s standing in this segment. Clearly, product positioning provides a valuable tool for designing creative strategies for business markets. The Technology Adoption Life Cycle After decades of being content with letters, telegrams, and telephones, consumers have embraced voice-mail, e-mail, Internet browsers, and a range of information appliances. In each case, the conversion of the market came slowly. Once a particular threshold of consumer acceptance was achieved, there was a stampede. Geoffrey 38This section is based largely on Behram J. Hansotia, Muzaffar A. Shaikh, and Jagdish N. Sheth, “The Strategic Determinancy Approach to Brand Management,” Business Marketing 70 (Fall 1985): pp. 66–69. 224 Part IV Formulating Business Marketing Strategy TABLE 8.1 THE TECHNOLOGY ADOPTION LIFE CYCLE: CLASSES OF CUSTOMERS Customer Profile Technology enthusiasts (innovators) Interested in exploring the latest innovation, these consumers possess significant influence over how products are perceived by others in the organization but lack control over resource commitments. Desiring to exploit the innovation for a competitive advantage, these consumers are the true revolutionaries in business and government who have access to organizational resources but frequently demand special modifications to the product that are difficult for the innovator to provide. Making the bulk of technology purchases in organizations, these individuals believe in technology evolution, not revolution, and seek products from a market leader with a proven track record of providing useful productivity improvements. Pessimistic about their ability to derive any value from technology investments, these individuals represent a sizable group of customers who are price sensitive and reluctantly purchase high-tech products to avoid being left behind. Rather than potential customers, these individuals are everpresent critics of the hype surrounding high-technology products. Visionaries (early adopters) Pragmatists (early majority) Conservatives (late majority) Skeptics (laggards) SOURCE: Adapted from Geoffrey A. Moore, Inside the Tornado: Marketing Strategies from Silicon Valley’s Cutting Edge (New York: HarperCollins, 1995), pp. 14–18. Moore defines discontinuous innovations as “new products or services that require the end-user and the marketplace to dramatically change their past behavior, with the promise of gaining equally dramatic new benefits.”39 During the past quarter century, discontinuous innovations have been common in the computer-electronics industry, creating massive new spending, fierce competition, and a whole host of firms that are redrawing the boundaries of the high-technology marketplace. A popular tool with strategists at high-technology firms is the technology adoption life cycle—a framework developed by Geoffrey Moore, a leading consultant to Hewlett-Packard and a host of other Silicon Valley firms. Types of Technology Customers Fundamental to Moore’s framework are five classes of customers who constitute the potential market for a discontinuous innovation (Table 8.1). Business marketers can benefit by putting innovative products in the hands of technology enthusiasts. They serve as a gatekeeper to the rest of the technology life cycle, and their endorsement is needed for an innovation to get a fair hearing in the organization. Whereas technology enthusiasts possess influence, they do not have ready access to the resources needed to move an organization toward a large-scale commitment to the new technology. 39Geoffrey A. Moore, Inside the Tornado: Marketing Strategies from Silicon Valley’s Cutting Edge (New York: HarperCollins, 1995), p. 13. Chapter 8 Managing Products for Business Markets 225 INSIDE BUSINESS MARKETING The Gorilla Advantage in High-Tech Markets High-tech companies that can get their products designed into the very standards of the market have enormous influence over the future direction of that market. For example, all PC-based software has to be Microsoft- and Intel-compatible. All networking solutions must be compatible with Cisco Systems’ standards; all printers must be Hewlett-Packard–compatible. This is the essence of gorilla power in high-tech markets that firms such as Microsoft, Intel, Cisco, and HewlettPackard enjoy. The gorilla advantage allows these market leaders to • Attract more customers by enjoying better press coverage and shorter sales cycles just because information technology managers expect it to be the winner; • Keep more customers because the cost of switching is high for customers and the cost of entry is high for competitors; • Drive costs down by shifting some costly enhancements that customers demand to suppliers while retaining control of the critical components of value creation; • Keep profits up because business partners place a priority on developing complementary products and services that make the whole product of the market leader worth more to customers than competing products are worth. The Internet presents an explosive area of growth in many sectors of the high-tech market as firms square off to gain a leadership position in e-procurement, wireless technologies, supply chain integration, and Web-focused security. The gorilla games are just beginning! SOURCE: Geoffrey A. Moore, Paul Johnson, and Tom Kippola, The Gorilla Game: An Investor’s Guide to Picking Winners in HighTechnology (New York: HarperBusiness, 1998), pp. 43–70. By contrast, visionaries have resource control and can often be influential in publicizing an innovation’s benefits and giving it a boost during the early stages of market development. However, visionaries are difficult for a marketer to serve because each demands special and unique product modifications. Their demands can quickly tax a technology firm’s R&D resources and stall the market penetration of the innovation. The Chasm Truly innovative products often enjoy a warm welcome from early technology enthusiasts and visionaries, but then sales falter and often even plummet. Frequently, a chasm develops between visionaries who are intuitive and support revolution and the pragmatists who are analytical, support evolution, and provide the pathway to the mainstream market. The business marketer that can successfully guide a product across the chasm creates an opportunity to gain acceptance with the mainstream market of pragmatists and conservatives. As Table 8.1 relates, pragmatists make most technology purchases in organizations, and conservatives include a sizable group of customers who are hesitant to buy high-tech products but do so to avoid being left behind. Strategies for the Technology Adoption Life Cycle The fundamental strategy for crossing the chasm and moving from the early market to the mainstream market is to provide pragmatists with a 100 percent solution to their problems (Figure 8.5). Many high-technology firms err by attempting to provide something for everyone while never meeting the complete requirements of any 226 Part IV Formulating Business Marketing Strategy Text not available due to copyright restrictions particular market segment. Pragmatists seek the whole product—the minimum set of products and services that provide them with a compelling reason to buy. Geoffrey Moore notes that “the key to a winning strategy is to identify a simple beachhead of pragmatist customers in a mainstream market segment and to accelerate the formation of 100 percent of their whole product. The goal is to win a niche foothold in the mainstream as quickly as possible—that is what is meant by crossing the chasm.”40 The Bowling Alley In technology markets, each market segment is like a bowling pin, and the momentum from hitting one segment successfully carries over into surrounding segments. The bowling alley represents a stage in the adoption life cycle where a product gains acceptance from mainstream market segments but has yet to be adopted widely. Consider the evolution of strategy for Lotus Notes.41 When first introduced, Notes was offered as a new paradigm for corporate-wide communication. To cross into the mainstream market, the Lotus team shifted the product’s focus from an enterprise-wide vision of corporate communication to specific solutions for particular business functions. The first niche served was the global account-management function of worldwide accounting and consulting firms. The solution was enhanced account activity coordination for highly visible products. This led to a second niche—global account management for sales teams, where enhanced coordination and information sharing spur productivity. 40Ibid., p. 22. For a related discussion, see Clayton M. Christensen and Michael E. Raynor, The Innovator’s Solution: Creat- ing and Sustaining Successful Growth (Boston: Harvard Business School Press, 2003), pp. 73–95. 41Moore, Inside the Tornado, pp. 35–37. Chapter 8 Managing Products for Business Markets 227 A Focused Strategy A logical next step for Lotus was movement into the customer service function, where openly sharing information can support creative solutions to customer problems. Successful penetration of these segments created another opportunity—incorporating the customer into the Notes loop. Note the key lesson here: A customer-based, application-focused strategy provides leverage so that a victory in one market segment cascades into victories in adjacent market segments. The Tornado Although economic buyers who seek particular solutions are the key to success in the bowling alley, technical or infrastructure buyers in organizations can spawn a tornado (see Figure 8.5). Information technology (IT) managers are responsible for providing efficient and reliable infrastructures—the systems organizational members use to communicate and perform their jobs. They are pragmatists, and they prefer to buy from an established market leader. IT professionals interact freely across company and industry boundaries and discuss the ramifications of the latest technology. IT managers watch each other closely—they do not want to be too early or too late. Often, they move together and create a tornado. Because a massive number of new customers are entering the market at the same time and because they all want the same product, demand dramatically outstrips supply and a large backlog of customers can appear overnight. At a critical stage, such market forces have surrounded Hewlett-Packard’s laser and inkjet printers, Microsoft’s Windows products, Intel’s Pentium microprocessors, and Research in Motion’s BlackBerry device. Tornado Strategy The central success factors for the tornado phase of the adoption life cycle differ from those that are appropriate for the bowling alley. Rather than emphasizing market segmentation, the central goal is to gear up production to capitalize on the opportunity the broad market presents. In its printer business, HewlettPackard demonstrated the three critical priorities during a tornado42: 1. “Just ship.” 2. Extend distribution channels. 3. Drive to the next lower price point. First, Hewlett-Packard’s quality improvement process allowed it to significantly increase production—first with laser printers, and later with inkjet printers—with few interruptions. Second, to extend market coverage, H-P began to sell its laser printers through PC dealer channels and extended its distribution channels for inkjet printers to computer superstores, office superstores, mail order, and, more recently, to price clubs and other consumer outlets. Third, H-P drove down the price points for its printers—moving inkjet printers below $1,000, then below $500, and then well below that. As this example demonstrates, tornado strategy emphasizes product leadership and operational excellence in manufacturing and distribution. 42Ibid., p. 81. See also Stephen Kreider Yoder, “Shaving Back: How H-P Used Tactics of the Japanese to Beat Them at Their Game,” The Wall Street Journal, September 8, 1994, pp. A1, A6. 228 Part IV Formulating Business Marketing Strategy Main Street This stage of the technology adoption life cycle represents a period of aftermarket development. The frantic waves of mass-market adoption of the product begin to subside. Competitors in the industry have increased production, and supply now exceeds demand. Moore points out that “the defining characteristic of Main Street is that continued profitable market growth can no longer come from selling the basic commodity to new customers and must come instead from developing niche-specific extensions to the basic platform for existing customers.”43 Main Street Strategy The goal here is to develop value-based strategies targeted to particular end-user segments. H-P, for example, matches its printers to the special needs of different segments of home-office users by offering • A compact portable printer for those users who are space-constrained; • The OfficeJet printer-fax for those who do not yet own a fax; • A high-performance color printer for those who create commercial flyers. Main Street strategy emphasizes operational excellence in production and distribution as well as finely tuned market segmentation strategies. What signals the end of the technology adoption life cycle? A discontinuous innovation appears that incorporates breakthrough technology and promises new solutions for customers. Summary Some of the most valuable and enduring global brands belong to business-to-business firms. The power of a brand resides in the minds of customers through what they have experienced, seen, and heard about the brand over time. The customer-based brand equity model consists of four steps: establishing the right brand identity, defining the meaning of the brand through unique brand associations, developing responsive marketing programs to elicit a positive brand response from customers, and building brand relationships with customers, marked by loyalty and active engagement. Research vividly demonstrates that investments in building a strong brand yield a positive payoff in the financial performance of the firm. Conceptualizing a product must go beyond mere physical description to include all the benefits and services that provide value to customers. The unifying goal for the business marketer: Provide superior market-perceived quality and value versus competitors. To a business customer, value involves a trade-off between benefits and sacrifices. Business marketers can strengthen customer relationships by providing value-added services and helping customers reduce operations costs. A carefully coordinated product strategy recognizes the role of various functional areas in providing value to business customers. Special attention should be given to synchronizing the activities among the product-management, sales, and service units. Industrial product lines can be broadly classified into (1) proprietary or catalog items, (2) custom-built items, (3) custom-designed items, and (4) industrial services. 43Moore, Inside the Tornado, p. 111. Chapter 8 Managing Products for Business Markets 229 Product management can best be described as the management of capability. In monitoring product performance and in formulating marketing strategy, the business marketer can profitably use product-positioning analysis. By isolating a product’s competitive standing in a market, positioning analysis provides strategy insights to the planner. A product attribute is determinant if it is both important and differentiating. Rapidly changing high-technology markets present special opportunities and challenges for the product strategist. The technology adoption life cycle includes five categories of customers: technology enthusiasts, visionaries, pragmatists, conservatives, and skeptics. New products gain acceptance from niches within the mainstream market, progress from segment to segment like one bowling pin knocking over another, and, if successful, experience the tornado of general, widespread adoption by pragmatists. Importantly, the technology adoption life cycle calls for different marketing strategies at different stages. Discussion Questions 1. Evaluate this statement: A brand is much more than a name, and branding is a strategy problem, not a naming problem. 2. Identify two business-to-business brands that you would deem to be strong and distinctive. Next, describe the characteristics of each brand that tend to set it apart from rival brands. 3. Using the customer-based brand equity framework as a guide, describe the distinctive components of Apple’s brand strategy. 4. Describe why a brand-positioning strategy should include points of difference and points of parity. Provide an illustration to support your case. 5. Regis McKenna notes that “no company in a technology-based industry is safe from unanticipated bumps in the night.” In recent years, many industries have been jolted by technological change. In such an environment, what steps can a product strategist take? 6. Bradley Gale, managing director of The Strategic Planning Institute, says: “People systematically knock out income statements and balance sheets, but they often don’t monitor the nonfinancial factors that ultimately drive their financial performance. These nonfinancial factors include ‘relative customer-perceived quality’: how customers view the marketer’s offering versus how they perceive competitive offerings.” Explain. 7. Distinguish among catalog items, custom-built items, custom-designed items, and services. Explain how marketing requirements vary across these classifications. 8. A particular product strategy will stimulate a response from the market and a corresponding response from competitors. Which specific features of the competitive environment should the business marketing strategist evaluate? 230 Part IV Formulating Business Marketing Strategy 9. Moving across the technology adoption life cycle, compare and contrast technology enthusiasts with pragmatists. Give special attention to the strategy guidelines that the marketing strategist should follow in reaching customers that fall into these two adoption categories. 10. Firms like Microsoft, Apple, Sony, and Intel have experienced a burst of demand for some of their products. During the “tornado” for a hightech product, the guiding principle of operations for a market leader is “Just ship.” Explain and discuss the changes in marketing strategy the firm must follow after the tornado. Internet Exercise 1. United Technologies Corporation (UTC) provides a broad range of high-technology products and support services to the building systems and aerospace industries. Go to http://www.utc.com and identify UTC’s major businesses (product lines). CASE Cisco TelePresence: The “As if you were there” Technology44 Research demonstrates that visual clues—such as raising an eyebrow or slumping the shoulders—comprise more than 50 percent of the information conveyed in a conversation. Unfortunately, until now, video technologies failed to provide the necessary fidelity to transmit these revealing clues effectively. However, Cisco Systems has created a two-way video communications system that preserves all those important nuances, in the process pioneering a new form of digital communications that rivals the effectiveness of in-person meetings. Twenty-five patents are pending for the Cisco TelePresence “as if you were there” technology. One industry analyst observed that video conferencing is like riding a 10-speed bike while TelePresence is like driving a Ferrari. Benefits By reducing the need for in-person face-to-face meetings, organizations can reap significant benefits from reduced travel costs, greater productivity, and better relationships with customers and partners. For global companies, executive travel is disruptive, costly, and time-consuming. Why travel to meet in person if you can communicate just as effectively through TelePresence? The Price Tag The Cisco TelePresence 3000 costs approximately $300,000 for each installation, or room, plus additional support costs. By contrast, the Cisco TelePresence 1000 is priced at $80,000 per room. As the price of key TelePresence technologies, such as plasma screens and broadband connections, will almost certainly continue to decline rapidly, Cisco believes that the system will enjoy a wider array of applications, making it affordable for more organizations and even for individuals from home. Discussion Questions 1. Using the technology life cycle as a framework, propose particular marketing strategies that Cisco might employ to “cross the chasm.” 2. Identify particular market segments that Cisco might target for the TelePresence product. 44“Cisco Brings ‘In-Person’ Realism to Virtual Communications,” accessed at http://www.cisco.com/en/US/products/ ps7060/index.html on July 15, 2008. 231 CHAPTER 9 Managing Innovation and New Industrial Product Development The long-term competitive position of most organizations is tied to their ability to innovate—to provide existing and new customers with a continuing stream of new products and services. Innovation is a high-risk and potentially rewarding process. After reading this chapter, you will understand: 1. the strategic processes, both formal and informal, through which product innovations take shape. 2. the characteristics of innovation winners in high-technology markets. 3. the factors that drive a firm’s new product performance. 4. the determinants of new product success and timeliness. 232 Chapter 9 Managing Innovation and New Industrial Product Development 233 With his American swagger and his hair bleached white, Tony Fadell stood out at button-down Philips Electronics, where he led an in-house operation designing . . . consumer electronics devices. It was there that he came up with the idea of marrying a Napster-like music store with a hard drive-based MP3 player. He shopped the concept around the Valley before Apple’s Jon Rubenstein snapped it up and put Fadell in charge of the engineering team that built the first iPod.1 Once prototypes were developed, CEO Steve Jobs worked closely with the team and was instrumental in molding the shape, feel, and design of the device.2 “Ambitious and charismatic (and no longer a bleached blond), Tony now runs the hardware division that makes two of Apple’s three product lines: the iPod and the iPhone.”3 Many firms derive much of their sales and profits from recently introduced products. Indeed, best-practice firms generate about 48 percent of sales and 45 percent of profits from products commercialized in the past five years.4 But the risks of product innovation are high; significant investments are involved and the likelihood of failure is high. With shortening product life cycles and accelerating technological change, speed and agility are central to success in the innovation battle. This chapter examines product innovation in the business marketing environment. The first section provides a perspective on the firm’s management of innovation. Second, product innovation is positioned within a firm’s overall technological strategy. Third, key dimensions of the new-product-development process are examined. Attention centers on the forces that drive successful new product performance in the firm. The final section of the chapter explores the determinants of new product success and timeliness. The Management of Innovation Management practices in successful industrial firms reflect the realities of the innovation process itself. James Quinn asserts that “innovation tends to be individually motivated, opportunistic, customer responsive, tumultuous, nonlinear, and interactive in its development. Managers can plan overall directions and goals, but surprises are likely to abound.”5 Clearly, some new-product-development efforts are the outgrowth of deliberate strategies (intended strategies that become realized), whereas others result from emergent strategies (realized strategies that, at least initially, were never intended).6 Bearing little resemblance to a rational, analytical process, many strategic decisions involving new products are rather messy, disorderly, and disjointed processes around which competing organizational factions contend. In studying 1“After Steve Jobs: Apple’s Next CEO—Tony Fadell (2),” June 26, 2008, accessed at http://money.cnn.com/galleries/2008/ fortune/0806/gallery.apple_jobs_successors.fortune/2.html on July 16, 2008. 2Leander Kahney, “Inside Look at Birth of iPod,” July 21, 2004, accessed at http://www.wired.com/gadgets/mac/ news/2004/07/64286 on June 3, 2008. 3“After Steve Jobs: Apple’s Next CEO.” 4 John Hauser, Gerald J. Tellis, and Abbie Griffin, “Research on Innovation: A Review and Agenda for Marketing Science,” Marketing Science 25 (November–December 2006): p. 707. 5James B. Quinn, “Managing Innovation: Controlled Chaos,” Harvard Business Review 63 (May–June 1985): p. 83. 6Henry Mintzberg and James A. Walton, “Of Strategies, Deliberate and Emergent,” Strategic Management Journal 6 ( July–August 1985): pp. 257–272. 234 Part IV Formulating Business Marketing Strategy successful innovative companies such as Sony, AT&T, and Hewlett-Packard, Quinn characterized the innovation process as controlled chaos: Many of the best concepts and solutions come from projects partly hidden or “bootlegged” by the organization. Most successful managers try to build some slack or buffers into their plans to hedge their bets. . . . They permit chaos and replications in early investigations, but insist on much more formal planning and controls as expensive development and scale-up proceed. But even at these later stages, these managers have learned to maintain flexibility and to avoid the tyranny of paper plans.7 Some new products result from a planned, deliberate process, but others follow a more circuitous and chaotic route.8 Why? Research suggests that strategic activity within a large organization falls into two broad categories: induced and autonomous strategic behavior.9 Induced Strategic Behavior Induced strategic behavior is consistent with the firm’s traditional concept of strategy. It takes place in relationship to its familiar external environment (for example, its customary markets). By manipulating various administrative mechanisms, top management can influence the perceived interests of managers at the organization’s middle and operational levels and keep strategic behavior in line with the current strategy course. For example, existing reward and measurement systems may direct managers’ attention to some market opportunities and not to others. Examples of induced strategic behavior or deliberate strategies might emerge around product-development efforts for existing markets. Autonomous Strategic Behavior During any period, most strategic activity in large, complex firms is likely to fit into the induced behavior category. However, large, resource-rich firms are likely to possess a pool of entrepreneurial potential at operational levels, which expresses itself in autonomous strategic initiatives. The 3M Company encourages its technical employees to devote 15 percent of their work time to developing their own ideas. Through the personal efforts of individual employees, new products are born. For example, • Gary Fadell is the engineering genius behind the iPod. • Art Fry championed Post-it notes at 3M. • P. D. Estridge promoted the personal computer at IBM. • Stephanie L. Kwolek advanced the bulletproof material Kevlar at DuPont. • Michimosa Fujino championed the HondaJet (see Figure 9.1) that may shake up the small-jet business with the same value proposition—high fuel efficiency and sleek design—that the first-generation Honda Civic used to rattle U.S. auto manufacturers 30 years ago.10 7Quinn, “Managing Innovation,” p. 82. 8This section is based on Michael D. Hutt, Peter H. Reingen, and John R. Ronchetto Jr., “Tracing Emergent Processes in Marketing Strategy Formation,” Journal of Marketing 52 (January 1988): pp. 4–19. 9Robert A. Burgelman, “A Process Model of Internal Corporate Venturing in the Diversified Major Firm,” Administrative Science Quarterly 28 (April 1983): pp. 223–244. 10 This discussion is based on Norihiko Shirouzu, “Mr. Fujino’s Bumpy Flight Lands Honda in the Jet Age,” The Wall Street Journal, June 18, 2007, pp. B1 and B3. Chapter 9 Managing Innovation and New Industrial Product Development Text not available due to copyright restrictions 235 236 Part IV Formulating Business Marketing Strategy “Civic of the Sky” Senior executives at Honda and industry analysts alike believe that the HondaJet can quickly gain 10 percent of the small-jet market and turn a profit in three to four years. Compared to the popular Cessna Citation CJ1+ that seats four to six passengers, the HondaJet is priced at $3.65 million, $880,000 below the Cessna, uses about 22 percent less fuel, has 20 percent more passenger cabin space, and boasts the fit and finish of a luxury car. Now in his mid-forties, Mr. Fujino has tirelessly promoted his idea for two decades. He succeeded in keeping the project alive by nurturing ties to senior executives and by tying his risk-taking to Honda’s broader efforts to rekindle a spirit of innovation. Although formal reviews of the jet project have been intense and even “ugly” at times, he persevered because, behind the scenes, some senior executives enthusiastically supported his efforts. A crucial turning point for the project came at a critical board meeting where Mr. Fujino was presenting the idea. After an awkward start and what he describes as a “cold glaze” from some board members, “he was able to drive home the jet’s potential when he analogized it to Honda’s breakthrough car, calling the jet a ‘Civic of the sky.’”11 Autonomous strategic behavior is conceptually equivalent to entrepreneurial activity and introduces new categories of opportunity into the firm’s planning process. Managers at the product-market level conceive of market opportunities that depart from the current strategy course, then engage in product-championing activities to mobilize resources and create momentum for further development of the product. Emphasizing political rather than administrative channels, product champions question the firm’s current concept of strategy and, states Robert Burgelman, “provide top management with the opportunity to rationalize, retroactively, successful autonomous strategic behavior.”12 Through these political mechanisms, successful autonomous strategic initiatives, or emergent strategies, can become integrated into the firm’s concept of strategy. Clayton M. Christensen and Michael E. Raynor observe: Emergent strategies result from managers’ responses to problems or opportunities that were unforeseen in the analysis and planning stages of the deliberate strategy making process. When the efficacy of that strategy . . . is recognized, it is possible to formalize it, improve it, and exploit it, thus transforming an emergent strategy into a deliberate one.13 Product Championing and the Informal Network Table 9.1 highlights several characteristics that may distinguish induced from autonomous strategic behavior. Autonomous strategic initiatives involve a set of actors and evoke strategic dialogue different from that found in induced initiatives. An individual manager, the product champion, assumes a central role in sensing an opportunity and in mobilizing an informal network to explore the idea’s technical feasibility and market potential. A product champion is an organization member who creates, defines, or adopts an idea for an innovation and is willing to assume significant risk (for example, position or prestige) to successfully implement the innovation.14 11 Ibid., p. B3. 12 Robert A. Burgelman, “Corporate Entrepreneurship and Strategic Management: Insights from a Process Study,” Management Science 29 (December 1983): p. 1352. 13Clayton M. Christensen and Michael E. Raynor, The Innovator’s Solution: Creating and Sustaining Successful Growth (Boston: Harvard Business School Press, 2003), pp. 215–216. 14Modesto A. Maidique, “Entrepreneurs, Champions, and Technological Innovations,” Sloan Management Review 21 (Spring 1980): pp. 59–70; see also Jane M. Howell, “Champions of Technological Innovation,” Administrative Science Quarterly 35 (June 1990): pp. 317–341. Chapter 9 TABLE 9.1 Managing Innovation and New Industrial Product Development 237 INDUCED VERSUS AUTONOMOUS STRATEGIC BEHAVIOR: SELECTED CHARACTERISTICS OF THE MARKETING STRATEGY FORMULATION PROCESS Induced Autonomous Activation of the strategic decision process An individual manager defines a market need that converges on the organization’s concept of strategy. An individual manager defines a market need that diverges from the organization’s concept of strategy. Nature of the screening process A formal screening of technical and market merit is made using established administrative procedures. An informal network assesses technical and market merit. Type of innovation Incremental (e.g., new product development for existing markets uses existing organizational resources). Major (e.g., new product development projects require new combinations of organizational resources). Nature of communication Consistent with organizational work flow. Departs from organizational work flow in early phase of decision process. Major actors Prescribed by the regular channel of hierarchical decision making. An informal network emerges based on mobilization efforts of the product champion. Decision roles Roles and responsibilities for participants in the strategy formulation process are well defined. Roles and responsibilities of participants are poorly defined in the initial phases but become more formalized as the strategy formulation process evolves. Implications for strategy Strategic alternatives are considered and commitment to a particular strategic course evolves. Commitment to a particular strategic course emerges in the early phases through the sponsorship efforts of the product champion. SOURCE: Adapted from Michael D. Hutt, Peter H. Reingen, and John R. Ronchetto Jr., “Tracing Emergent Processes in Marketing, Strategy Formation,” Journal of Marketing 52 (January 1988): pp. 4–19. See also Clayton M. Christensen and Michael E. Raynor, The Innovator’s Solution: Creating and Sustaining Successful Growth (Boston: Harvard Business School Press, 2003), pp. 213–231. Senior managers at 3M do not commit to a project unless a champion emerges and do not abandon the effort unless the champion “gets tired.” Emphasizing a rich culture of innovation embraced by all employees, senior executives at 3M also encourage product-championing behavior and calculated risk-taking. Moreover, they tolerate what 3M employees call “well-intentioned” failures.15 Compared with induced strategic behavior, autonomous or entrepreneurial initiatives are more likely to involve a communication process that departs from the regular work flow and the hierarchical decision-making channels. The decision roles and responsibilities of managers in this informal network are poorly defined in the early phases of the strategy-formulation process but become more formalized as the process evolves. Note in Table 9.1 that autonomous strategic behavior entails a creeping commitment toward a particular strategy course. By contrast, induced strategic initiatives are more likely to involve administrative mechanisms that encourage a more formal and comprehensive assessment of strategic alternatives at various levels in the firm’s planning hierarchy. 15 George S. Day, “Managing the Market Learning Process,” Journal of Business & Industrial Marketing 17 (4, 2002): p. 246. 238 Part IV Formulating Business Marketing Strategy Conditions Supporting Corporate Entrepreneurship16 Entrepreneurial initiatives cannot be precisely planned but they can be nurtured and encouraged. First, the availability of appropriate rewards can enhance a manager’s willingness to assume the risks associated with entrepreneurial activity. Second, as 3M illustrates, senior management can assume an instrumental role in fostering innovation by promoting entrepreneurial initiatives and encouraging calculated risk-taking. Third, resource availability, including some slack time, is needed to provide entrepreneurs with some degrees of freedom to explore new possibilities. 3M encourages scientists to devote up to 15 percent of their time to particular projects that they find personally interesting. Fourth, an organizational structure supporting corporate entrepreneurship provides the administrative mechanisms that bring more voices to the innovation process across the firm and allow ideas to be evaluated, selected, and implemented.17 What Motivates Entrepreneurs? Recent research identifies two additional dimensions that motivate corporate entrepreneurs: (1) intrinsic motivation (the drive originating within oneself) and (2) work design (for example, the availability of challenging projects; opportunities to interact directly with customers and other entrepreneurs). Matthew R. Marvel and his research colleagues describe what technical corporate entrepreneurs desire in their job: They want their innovative efforts to be connected to customer problems that need to be solved—and important customer problems at that. To understand these problems, they need contact with customers. To get breakthrough ideas on how to solve these problems, they also need contact with other world-class technologists.18 Managing Technology Kodak, Lockheed, IBM, and the management teams of other corporations failed to recognize the major technological opportunity that xerographic copying presented. These firms were among the many that turned down the chance to participate with the small and unknown Haloid Company in refining and commercializing this technology. In the end, Haloid pursued it alone and transformed this one technological opportunity into the Xerox Corporation. Among the “tales of high tech,” this remains a classic.19 Technological change, Michael Porter asserts, is “a great equalizer, eroding the competitive advantage of even well-entrenched firms and propelling others to the forefront. Many of today’s great firms grew out of technological changes that they were able to exploit.”20 Clearly, the long-run competitive position of most businessto-business firms depends on their ability to manage, increase, and exploit their technology base. This section explores the nature of development projects, the disruptive 16 This section is based on Matthew R. Marvel, Abbie Griffin, John Hebda, and Bruce Vojak, “Examining the Technical Corporate Entrepreneurs’ Motivation: Voices from the Field,” Entrepreneurship Theory and Practice, 31 (September 2007): pp. 753–768. 17 Gary Hamel, “The Why, What, and How of Management Innovation,” Harvard Business Review 84 (February 2006): pp. 72–84. 18Marvel, Griffin, Hebda, and Vojak, “Examining the Technical Corporate Entrepreneurs’ Motivation,” p. 764. 19For a related discussion of Xerox’s technology blunders, see Andrew Hargadon, How Breakthroughs Happen: The Surprising Truth about How Companies Innovate (Boston: Harvard Business School Press, 2003), pp. 168–182. 20Michael E. Porter, “Technology and Competitive Advantage,” Journal of Business Strategy 6 (Winter 1985): p. 60; and Tamara J. Erickson, John F. Magee, Philip A. Roussel, and Komol N. Saad, “Managing Technology as Business Strategy,” Sloan Management Review 31 (Spring 1990): pp. 73–83. Chapter 9 Managing Innovation and New Industrial Product Development 239 innovation model, and the defining attributes of successful innovators in fast-changing high-technology markets. Classifying Development Projects A first step in exploring the technology portfolio of a firm is to understand the different forms that development projects can take. Some development projects center on improving the manufacturing process, some on improving products, and others on both process and product improvements. All of these represent commercial development projects. By contrast, research and development is the precursor to commercial development. A firm’s portfolio can include four types of development projects.21 1. Derivative projects center on incremental product enhancements (for example, a new feature), incremental process improvements (for example, a lower-cost manufacturing process), or incremental changes on both dimensions. Illustration: A feature-enhanced or cost-reduced Canon color copier. 2. Platform projects create the design and components shared by a set of products. These projects often involve a number of changes in both the product and the manufacturing process. Illustrations: A common motor in all Black & Decker hand tools; multiple applications of Intel’s microprocessor. 3. Breakthrough projects establish new core products and new core processes that differ fundamentally from previous generations. Illustrations: Computer disks and fiber-optic cable created new product categories. 4. Research and development is the creation of knowledge concerning new materials and technologies that eventually leads to commercial development.22 Illustration: Cisco Systems’ development of communications technology that underlies its networking systems used by diverse customers like retailers, banks, and hotel chains. A Product-Family Focus A particular technology may provide the foundation or platform for several products. For example, Honda applies its multivalve cylinder technology to power-generation equipment, cars, business jets, motorcycles, and lawn mowers.23 Products that share a common platform but have different specific features and enhancements required for different sets of consumers constitute a product family.24 Each generation of 21This discussion is based on Steven C. Wheelwright and Kim B. Clark, “Creating Product Plans to Focus Product Develop- ment,” Harvard Business Review 70 (March–April 1992): pp. 70–82. 22Ibid., p. 74. 23T. Michael Nevens, Gregory L. Summe, and Bro Uttal, “Commercializing Technology: What the Best Companies Do,” Harvard Business Review 60 (May–June 1990): pp. 154–163; see also C. K. Prahalad, “Weak Signals versus Strong Paradigms,” Journal of Marketing Research 32 (August 1995): pp. iii–vi. 24Marc H. Meyer and James M. Utterback, “The Product Family and the Dynamics of Core Capability,” Sloan Management Review 34 (Spring 1993): pp. 29–47; see also Dwight L. Gertz and João P. A. Baptista, Grow to Be Great: Breaking the Downsizing Cycle (New York: The Free Press, 1995), pp. 92–103. 240 Part IV Formulating Business Marketing Strategy a product family has a platform that provides the foundation for specific products targeted to different or complementary markets. By expanding on technical skills, market knowledge, and manufacturing competencies, entirely new product families may be formed, thereby creating new business opportunities. Strategists argue that a firm should move away from planning that centers on single products and focus instead on families of products that can grow from a common platform. Consider the Sony Walkman—one of the most successful products of all time. Based on how different customer segments used the product, Sony developed four basic platforms for the Walkman: playback only, playback and record, playback and tuner, and sports. Then, by applying standard design elements such as color and styling, Sony added an assortment of features and distinctive technical attributes to the basic platforms with relative ease.25 The move toward a product-family perspective requires close interfunctional working relationships, a long-term view of technology strategy, and a multipleyear commitment of resources. Although this approach offers significant competitive leverage, Steven Wheelwright and Kim Clark note that companies often fail to invest adequately in platforms: “The reasons vary, but the most common is that management lacks an awareness of the strategic value of platforms and fails to create well-thought-out platform projects.”26 The Disruptive Innovation Model27 Special insights into innovation management come from examining the rate at which products are improving and customers can use those improvements. For example, when personal computers were first introduced in the early 1980s, typists often had to pause for the Intel 286 chip to catch up. But today, only the most demanding customers can fully use the speed and performance of personal computers. For many products, from Excel spreadsheets to application-enriched handsets and information appliances, few customers absorb the performance features that innovating companies include as they introduce new and improved products. Overshooting Figure 9.2 shows, first, a rate of improvement in a given product or technology that customers can use, represented by the dotted line, sloping slightly upward across the chart. Second, for a given product, innovating firms offer a trajectory of improvement as they develop new and improved versions over time. The pace of technological progress usually outstrips the ability of many, if not most, customers to keep up with it (see the steeply sloping solid lines in Figure 9.2). Therefore, as companies strive to make better products they can sell at higher profit margins to the most demanding customers, they overshoot and provide much more performance than mainstream customers are able to use. Sustaining versus Disruptive Innovation Third, from Figure 9.2, a distinction is made between a sustaining innovation and a disruptive innovation. According to Clayton M. Christensen and Michael E. Raynor, “A sustaining innovation targets 25Kathleen M. Eisenhardt and Shona L. Brown, “Time Pacing: Competing in Markets That Won’t Stand Still,” Harvard Business Review, 76 (March–April 1998): p. 67. 26Wheelwright and Clark, “Creating Project Plans,” p. 74. 27This section is based on Christensen and Raynor, The Innovator’s Solution, pp. 31–65. See also, Ashish Sood and Gerard J. Tellis, “Technological Evolution and Radical Innovation,” Journal of Marketing 69 (July 2005): pp. 152–168. Chapter 9 FIGURE 9.2 Managing Innovation and New Industrial Product Development 241 THE DISRUPTIVE INNOVATION MODEL gress al Pro logic echno T f o e Performance Pac ining Susta ations Innov Performance That Customers Can Utilize or Absorb Range of Performance That Customers Can Utilize Disruptive Innovations Time SOURCE: Reprinted by permission of Harvard Business Review. From “Descriptive Innovation Model” in The Innovator’s Solution by Clayton Christensen. p. 30. Copyright © 2003 by the Harvard Business School Publishing Corporation; all rights reserved. demanding, high-end customers with better performance than what was previously available (for example, incremental product improvements or breakthrough products).”28 A disruptive innovation represents a product or service that is not as good as currently available alternatives. “But disruptive technologies offer other benefits— typically, they are simpler, more convenient, and less expensive products that appeal to new or less-demanding customers.”29 Disruptive Strategy Examples Once a disruptive product or service gains a foothold, the improvement cycle begins and eventually it intersects with the needs of more demanding customers. For example, Xerox held a commanding position in the high-speed photocopier business until Canon’s simple tabletop copier disrupted that strategy in the early 1980s. Likewise, Southwest Airlines disrupted established airlines; Amazon.com disrupted traditional bookstores; Staples disrupted small stationery stores and distributors of office supplies; and Google disrupted directories of all sorts, including Yellow Pages. Types of Disruptive Strategies Disruptive strategies can take two forms: lowend disruptions and new-market disruptions. Table 9.2 describes the characteristics of these strategies and contrasts them with a strategy geared to sustaining innovations. Note, for example, the targeted customers for low-end disruption are overserved customers, whereas new-market disruptions target nonconsumption—customers who historically lacked the resources to buy and use the product. 28Christensen and Raynor, The Innovator’s Solution, p. 34. 29 Ibid., p. 34. 242 Part IV Formulating Business Marketing Strategy TABLE 9.2 THREE APPROACHES TO CREATING NEW-GROWTH BUSINESSES Dimensions Targeted performance of the product or service Targeted customers or market application Effect on the required business model (processes and cost structure) Sustaining Innovations Low-End Disruptions New-Market Disruptions Performance improvement in attributes most valued by the industry’s most demanding customers. These improvements may be incremental or breakthrough in character. The most attractive (i.e., profitable) customers in the mainstream markets who are willing to pay for improved performance. Improves or maintains profit margins by exploiting the existing processes and cost structure and making better use of current competitive advantages. Performance that is good enough along the traditional metrics of performance at the low end of the mainstream market. Lower performance in “traditional” attributes, but improved performance in new attributes—typically simplicity and convenience. Overserved customers in the low end of the mainstream market. Targets nonconsumption: customers who historically lacked the money or skill to buy and use the product. Business model must make money at lower price per unit sold and at unit production volumes that initially will be small. Gross margin dollars per unit sold will be significantly lower. Uses a new operating or financial approach or both— a different combination of lower gross profit margins and higher asset utilization that can earn attractive returns at the discount prices required to win business at the low end of the market. SOURCE: Reprinted by permission of the Harvard Business Review. From “Three Approaches to Creating New Growth Business” in The Innovator’s Solution by Clayton Christensen, p. 51. Copyright © 2003 by the Harvard Business School Publishing Corporation; all rights reserved. Low-End Strategy Tests For a low-end disruptive strategy to succeed, two requirements must be met: 1. There should be customers at the low end of the market who are eager to purchase a “good-enough” product if they could acquire it at a lower price. 2. The company must be able to create a business model that can yield attractive profits at the discount prices that are needed to attract customers at the low end of the market. Example: Southwest Airlines drew customers away from the major carriers. New-Market Strategy Tests For new market disruptions, at least one and generally both of these requirements must be met: 1. A large population can be defined who have historically lacked the money, equipment, or skill to acquire this product or service for themselves. 2. Present customers need to go to an inconvenient location to use the product or service. Examples: Canon desktop photocopiers were a new-market disruption in the 1980s because they enabled employees to make their own copies rather than Chapter 9 Managing Innovation and New Industrial Product Development 243 taking their originals to the corporate high-speed copying center to get help from technical specialists. Also, Research in Motion Limited’s BlackBerry is a new-market disruption relative to notebook computers. A Final Litmus Test Once an innovation passes the tests that apply to low-end or new-market disruptions, a final critical test remains: The innovation must be disruptive to all the significant competitive firms in the industry. If one or more of the significant industry players is pursuing the strategy, the odds will be stacked against the new entrant. Illustration: A New-Market Disruption30 One principle for developing disruptive ideas is to “do what competitors want.” For instance, Salesforce.com has pursued a strategy that leaders in the customer relationship (CRM) software market—namely SAP and Oracle—found unappealing. Before Salesforce.com entered the market, both of these formidable rivals sold relatively expensive solutions that required customization and installation to ensure proper integration with the customer’s other software packages. Customers also were charged an ongoing fee for maintenance of the installed software. Adopting a Different Approach Salesforce.com provides customers with access to programs that reside on centralized host computers. Users access these databases through the Web for a modest monthly fee. While customers often find these hosted solutions to be occasionally slower and somewhat more difficult to readily integrate with other applications, they are flexible, easy to use, and quite economical—all defining characteristics of a disruptive innovation. Scott D. Anthony and his colleagues observe that “Salesforce.com used several tactics that made its competitors unwilling or uninterested in immediately responding: • It started with nonconsumption (that is, selling to small customers purchasing their first CRM software). • It targeted a customer its competitors considered undesirable (that is, small and medium-sized businesses that were the least profitable for rivals). • It used a different distribution channel (that is, on the Web). • It created a business model that did not depend on a revenue stream of vital importance to incumbents.”31 (By centering on installation and customization fees, SAP and Oracle did not find the fees related to a hosted model to be appealing.) Innovation Winners in High-Technology Markets In rapidly changing industries with short product life cycles and quickly shifting competitive landscapes, a firm must continually innovate to keep its offerings aligned with the market. A firm’s ability to cope with change in a high-velocity industry is a key 30Scott D. Anthony, Mark W. Johnson, Joseph V. Sinfield, and Elizabeth J. Altman, The Innovator’s Guide to Growth: Putting Disruptive Innovation to Work (Boston: Harvard Business Press, 2008), pp. 125–126. 31Ibid., p. 126. 244 Part IV Formulating Business Marketing Strategy to competitive success. Shona Brown and Kathleen Eisenhardt provide an intriguing comparison of successful versus less successful product innovation in the computer industry.32 Successful innovators were firms that were on schedule, on time to the market, and on target in addressing customer needs. The study found that firms with a successful record of product innovation use different organizational structures and processes than their competitors. In particular, four distinguishing characteristics marked the innovation approach of successful firms. 1. Limited Structure Creating successful products to meet changing customer needs requires flexibility, but successful product innovators combine this flexibility with a few rules that are never broken. First, strict priorities for new products are established and tied directly to resource allocation. This allows managers to direct attention to the most promising opportunities, avoiding the temptation to pursue too many attractive opportunities. Second, managers set deadlines for a few key milestones and always meet them. Third, responsibility for a limited number of major outcomes is set. For example, at one firm, engineering managers were responsible for product schedules while marketing managers were responsible for market definition and product profitability. Although successful firms emphasized structure for a few areas (for example, priorities or deadlines), less successful innovators imposed more control—lockstep, checkpoint procedures for every facet of new product development—or virtually no structure at all. Successful firms strike a balance by using a structure that is neither so rigid as to stiffly control the process nor so chaotic that the process falls apart. 2. Real-Time Communication and Improvisation Successful product innovators in the computer industry emphasize real-time communication within new-productdevelopment teams and across product teams. Much of the communication occurs in formal meetings, but there is also extensive informal communication throughout the organization. Clear priorities and responsibilities, coupled with extensive communications, allow product developers to improvise. “In the context of jazz improvisation, this means creating music while adjusting to the changing musical interpretations of others. In the context of product innovation, it means creating a product while simultaneously adapting to changing markets and technologies.”33 More formally, then, improvisation involves the design and execution of actions that approach convergence with each other in time.34 The shorter the elapsed time between the design and implementation of an activity, the more that activity is improvisational. Successful firms expect constant change, and new product teams have the freedom to act. One manager noted: “We fiddle right up to the end” of the newproduct-development process. Real-time communications among members of the product development team, coupled with limited structure, provide the foundation for such improvisation. 32This section is based on Shona L. Brown and Kathleen M. Eisenhardt, “The Art of Continuous Change: Linking Complexity Theory and Time-Paced Evolution in Relentlessly Shifting Organizations,” Administrative Science Quarterly 42 (March 1997): pp. 1–34. 33Ibid., p. 15. 34Christine Moorman and Anne S. Miner, “The Convergence of Planning and Execution: Improvisation in New Product Development,” Journal of Marketing 62 (July 1998): p. 3. Chapter 9 Managing Innovation and New Industrial Product Development 245 INSIDE BUSINESS MARKETING Patching: The New Corporate Strategy in Dynamic Markets Kathleen M. Eisenhardt and Shona L. Brown contend that traditional corporate planning and resource allocation approaches are not effective in volatile markets. As new technologies, novel products and services, and emerging markets create tempting opportunities, “the clear-cut partitioning of businesses into neat, equidistant rectangles on an organizational chart becomes out of date.” The new corporate-level strategic processes center on managing change and continually realigning the organization to capture market opportunities faster than the competition. Central to this newly defined approach is patching—the strategic process corporate executives use routinely to realign or remap businesses to changing market opportunities. Patching can take the form of adding, dividing, transferring, exiting, or combining pieces of businesses. Hewlett-Packard used patching to launch the printer business, create businesses in related products like scanners and faxes, and develop a second printer business built around inkjet technology. Patching is less critical in stable markets but a crucial skill when markets are turbulent. Here a small, agile unit of the firm can be mobilized quickly to capture fresh market opportunities. SOURCES: Kathleen M. Eisenhardt and Shona L. Brown, “Patching: Restitching Business Portfolios in Dynamic Markets,” Harvard Business Review 77 (May–June 1999): pp. 72–82; see also, Mark B. Houston, Beth A. Walker, Michael D. Hutt, and Peter H. Reingen, “Cross-Unit Competition for a Market Charter: The Enduring Influence of Structure,” Journal of Marketing 65 (April 2001): pp. 19–34. 3. Experimentation: Probing into the Future Some firms make a large bet on one version of the future, whereas others fail to update future plans in light of changing competition. Creators of successful product portfolios did not invest in any one version of the future but, instead, used a variety of low-cost probes to create options. Examples of low-cost probes include developing experimental products for new markets, entering into a strategic alliance with leading-edge customers to better understand future needs, or conducting regular planning sessions dedicated to the future. In turbulent industries, strategists cannot accurately predict which of many possible versions of the future will arrive. Probes create more possible responses for managers when the future does arrive while lowering the probability of being surprised by unanticipated futures. 4. Time Pacing Successful product innovators carefully managed the transition between current and future projects, whereas less successful innovators let each project unfold according to its own schedule. Successful innovators, like Intel, practice time pacing—a strategy for competing in fast-changing markets by creating new products at predictable time intervals.35 Organization members carefully choreograph and understand transition processes. For example, marketing managers might begin work on the definition of the next product while engineering is completing work on the current product and moving it to manufacturing. Time pacing motivates managers to anticipate change and can have a strong psychological impact across the organization. “Time pacing creates a relentless sense of urgency around meeting deadlines and concentrates individual and team energy around common goals.”36 35Eisenhardt and Brown, “Time Pacing,” pp. 59–69. 36 Ibid., p. 60. 246 Part IV Formulating Business Marketing Strategy The New-Product-Development Process To sustain their competitive advantage, leading-edge firms such as Canon, Microsoft, and Hewlett-Packard make new product development a top management priority. They directly involve managers and employees from across the organization to speed actions and decisions. Because new product ventures can represent a significant risk as well as an important opportunity, new product development requires systematic thought. The high expectations for new products are often not fulfilled. Worse, many new industrial products fail. Although the definitions of failure are somewhat elusive, research suggests that 40 percent of industrial products fail to meet objectives.37 Although there may be some debate over the number of failures, there is no debate that a new product rejected by the market constitutes a substantial waste to the firm and to society. This section explores (1) the forces that drive a firm’s new product performance, (2) the sources of new product ideas, (3) cross-functional barriers to successful innovation, and (4) team-based processes used in new product development. A promising method for bringing the “voice of the consumer” directly into the development process is also explored. What Drives a Firm’s New Product Performance? A benchmarking study sought to uncover the critical success factors that drive a firm’s new product performance.38 It identified three factors (Figure 9.3): (1) the quality of a firm’s new-product-development process, (2) the resource commitments made to new product development, and (3) the new product strategy. Process Successful companies use a high-quality new-product-development process—they give careful attention to executing the activities and decision points that new products follow from the idea stage to launch and beyond. The benchmarking study identifi ed the following characteristics among high-performing firms: • The firms emphasized upfront market and technical assessments before projects moved into the development phase. • The process featured complete descriptions of the product concept, product benefits, positioning, and target markets before development work was initiated. • Tough project go/kill decision points were included in the process, and the kill option was actually used. • The new product process was flexible—certain stages could be skipped in line with the nature and risk of a particular project. 37Robert G. Cooper, Scott J. Edgett, and Elko J. Kleinschmidt, “Benchmarking Best NPD Practices–I,” Research Technology Management 47 (January–February 2004): pp. 31–43; see also Robert G. Cooper and Scott J. Edgett, “Maximizing Productivity in Product Innovation,” Research Technology Management 51 (March–April 2008): pp. 47–58. 38Robert G. Cooper and Elko J. Kleinschmidt, “Benchmarking Firms’ New Product Performance and Practices,” Engineering Management Review 23 (Fall 1995): pp. 112–120; see also Robert G. Cooper, Scott J. Edgett, and Elko J. Kleinschmidt, “Benchmarking Best NPD Practices–II,” Research Technology Management 47 (May–June 2004): pp. 50–59. Chapter 9 FIGURE 9.3 Managing Innovation and New Industrial Product Development 247 THE MAJOR DRIVERS OF A FIRM’S NEW PRODUCT PERFORMANCE DRIVERS ILLUSTRATIVE PERFORMANCE OUTCOMES New Product Development Process Success Rate of New Products New Product Strategy Resource Commitment A Firm's New Product Performance Profit Impact of New Products on Company Profitability Relative to Competition SOURCE: Adapted from Robert G. Cooper and Elko J. Kleinschmidt, “Benchmarking Firms’ New Product Performance and Practices,” Engineering Management Review 23 (Fall 1995): pp. 112–120. Detailed upfront homework on the product concept, the likely market response, and the product’s technical feasibility, along with a thorough business and financial assessment, are important dimensions of the process successful product creators follow. Resource Commitments Adequate resources were invested in new product development in top-performing firms. Three ingredients were important here: 1. Top management committed the resources necessary to meet the firm’s objectives for the total product effort. 2. R&D budgets were adequate and aligned with the stated new product objectives. 3. The necessary personnel were assigned and were relieved from other duties so that they could give full attention to new product development. Research suggests that rather than being imposed by top management, the creative potential of new-product-development teams “is likely to be more fully realized when they are given the flexibility—within a broad strategic directive—to determine their own project controls and especially to pursue their own processes and procedures.”39 39Joseph M. Bonner, Robert W. Ruekert, and Orville C. Walker Jr., “Upper Management Control of New Product Development Projects and Project Performance,” Journal of Product Innovation Management 19 (May 2002): p. 243. 248 Part IV Formulating Business Marketing Strategy New Product Strategy A clear and visible new product strategy was another driver of a firm’s new product performance (see Figure 9.3). Successful firms like 3M set aggressive new product performance goals (for example, x percent of company sales and profit from new products) as a basic corporate goal and communicate it to all employees. In turn, Robert Cooper and Elko Kleinschmidt report that successful firms centered development efforts on clearly defined arenas—particular product, market, and technology domains—to direct the new product program: The new product strategy specifies “the arenas where we’ll play the game,” or perhaps more important, where we won’t play . . . what’s in bounds and out of bounds. Without arenas defined, the search for new product ideas or opportunities is unfocused. . . .40 Anticipating Competitive Reactions41 Two-thirds of new product introductions trigger reactions by competitors. Consequently, business marketers can improve the odds of new-product-launch success by implementing a strong competitor orientation before and during the launch. Here the new product strategist develops detailed scenarios that provide a guide for countering different competitive responses. Competitors are strongly motivated to react when (1) the new product represents a major threat to their market and (2) the market is experiencing a high rate of growth. Competitors are also more inclined to react when extensive marketing communications by the innovating firm enhance the visibility of the new product introduction. Alternatively, if the new product introduction does not pose a direct challenge to the competitor’s market, a reaction is less likely. Recent research suggests that radically new products or products that target niche markets are less likely to spawn competitive responses. Sources of New Product Ideas The business marketer should be alert to new product ideas and their sources, both inside and outside the company. Internally, new product ideas may flow from salespersons who are close to customer needs, from R&D specialists who are close to new technological developments, and from top management who know the company’s strengths and weaknesses. Externally, ideas may come from channel members, such as distributors or customers, or from an assessment of competitive moves. Eric von Hippel challenges the traditional view that marketers typically introduce new products to a passive market.42 His research suggests that the customers in the 40Cooper and Kleinschmidt, “Benchmarking,” p. 117; see also Jean-Marie Choffray and Gary L. Lilien, “Assessing Response to Industrial Marketing Strategy,” Journal of Marketing 42 (April 1978): pp. 20–31; and Eunsang Yoon and Gary L. Lilien, “New Industrial Product Performance: The Effects of Market Characteristics and Strategy,” Journal of Product Innovation Management 3 (September 1985): pp. 134–144. 41Marion Debruyne, Rudy Moenart, Abbie Griffin, Susan Hart, Erik Jan Hultink, and Henry Robben, “The Impact of New Product Launch Strategies on Competitive Reaction in Industrial Markets,” Journal of Product Innovation Management 19 (March 2002): pp. 159–170; see also Beth A. Walker, Dimitri Kapelianis, and Michael D. Hutt, “Competitive Cognition,” MIT Sloan Management Review 46 (Summer 2005): pp. 10–12. 42Eric von Hippel, “Get New Products from Customers,” Harvard Business Review 60 (March–April 1982): pp. 117–122; see also Eric von Hippel, The Sources of Innovation (New York: Oxford University Press, 1988); Gerard A. Athaide and Rodney L. Stump, “A Taxonomy of Relationship Approaches during Technology Development in Technology-Based, Industrial Markets,” Journal of Product Innovation Management 16 (September 1999): pp. 469–482. Chapter 9 Managing Innovation and New Industrial Product Development 249 B2B TOP PERFORMERS IDEO: The Hits Just Keep on Coming! IDEO helps organizations innovate through design. Leading firms like Apple, Research In Motion, Sony, 3M, and others have used product design to define their brands, creating meaningful points of difference over competitors. Among their greatest hits, IDEO is responsible for designing • the Microsoft mouse; • the coasting bicycle design strategy for Shimano; • improved patient-provider services for Mayo Clinic; • “Keep the Change” account service for Bank of America. FastCompany.com identifies IDEO as one of the world’s most innovative companies. • the Swiffer Sweeper for Procter & Gamble; • mobile sound components for Altec Lansing; SOURCE: http://www.ideo.com/portfolio/list.asp?p=0&c=& k=40&s=&so=4 business market often develop the idea for a new product and even select the supplier to make that product. The customer is responding to the perceived capability of the business marketer rather than to a specific physical product. This points up the need for involving customers in new product development and promoting corporate capability to consumers (idea generators). Lead Users Because many industrial product markets for high-technology and, in particular, capital equipment consist of a small number of high-volume buying firms, special attention must be given to the needs of lead users. These include a small number of highly influential buying organizations that are consistent early adopters of new technologies.43 Lead users face needs that are general in the marketplace, but they confront these needs months or years before most of that marketplace encounters them. In addition, they are positioned to benefit significantly by obtaining a solution that satisfies those needs. For example, if an automobile manufacturer wanted to design an innovative braking system, marketing managers might secure insights from auto racing teams, who have a strong need for better brakes. In turn, they might look to a related field like aerospace, where antilock braking systems were first developed so that military aircraft could land on short runways.44 The Lead User Method Lead user projects are conducted by a cross-functional team that includes four to six managers from marketing and technical departments; one member serves as project leader. Team members typically spend 12 to 15 hours per week on the projects, which are usually completed in four to six weeks. Lead user projects proceed through five phases (Figure 9.4). 3M has now successfully used the lead user method in eight different divisions, and support among project teams and divisional managers is strong. For example, the Medical-Surgical Markets Group at 43von Hippel, “Get New Products,” pp. 120–121. 44Eric von Hippel, Stefan Thomke, and Mary Sonnack, “Creating Breakthroughs at 3M,” Harvard Business Review 77 (September–October 1999): pp. 47–57. 250 Part IV Formulating Business Marketing Strategy FIGURE 9.4 Phase THE LEAD USER METHOD Central Focus Description Phase 1 Laying the Foundation The team identifies target markets and secures support from internal stakeholders for the type and level of innovations desired. Phase 2 Determining the Trends The team talks to experts in the field who have a broad view of emerging technologies and pioneering applications in the particular area. Phase 3 Identifying Lead Users The team begins a networking process to identify lead users at the leading edge of the target market and to gather information that might contribute to breakthrough products. Phase 4 Developing & Assessing Preliminary Product Ideas The team begins to shape product ideas and to assess market potential and fit with company interests. Phase 5 Developing the Breakthroughs To design final concepts, the team hosts a workshop bringing together lead users with other in-house managers. After further refinement, the team presents its recommendations to senior management. SOURCE: Adapted with modifications from Eric von Hippel, Stefan Thomke, and Mary Sonnack, “Creating Breakthroughs at 3M,” Harvard Business Review 77 (September–October 1999), p. 52. 3M used the lead user method to unearth new product ideas and to identify a revolutionary approach to infection control.45 3M reports that sales in year 5 for funded lead user project ideas were more than eight times greater than those generated by traditional approaches to idea generation.46 Other firms adopting a lead user focus include Nortel Networks, Verizon, Nestle, Pitney Bowes, and Philips. Customer Visits A popular approach among business marketers for gaining new product insights is customer visits.47 Here a cross-functional team visits a customer organization to secure a first-hand account of customer needs. Based on a carefully crafted interview guide, in-depth interviews are conducted with key buying influentials to uncover user problems, needs, and desires. For instance, company representatives at Intuit visit customers where they live and work to observe how they use its products such as QuickBooks. After watching many small-business customers struggle with QuickBooks Pro, the firm saw a need and created the solution: QuickBooks Simple Start.48 Web-Based Methods for Improving Customer Inputs to Design Recognizing the ability of customers to innovate, many firms have developed tools that invite 45Ibid., p. 56. 46“User Innovation: Changing Innovation Focus,” Strategic Direction 23 (8, 2007): pp. 35–36. 47Robert Cooper and Scott Edgett, “Ideation for Product Innovation: What Are the Best Methods?” Product Development Institute, Inc., 2008, accessed at http://www.stage-gate.com on July 10, 2008. 48Christopher Meyer and Andre Schwager, “Understanding Customer Experience,” Harvard Business Review 85 (February 2007): p. 8. Chapter 9 Managing Innovation and New Industrial Product Development 251 customers to design their own products. With these innovative toolkits, customers are given an array of features that can be configured, as desired, to create their own customized products. These toolkits often incorporate engineering and cost modules. To illustrate, if a customer wishes to change the length of a truck bed, the design tool automatically computes the additional cost and the associated changes that will be required in both the transmission and the engine. For aesthetic compatibility, the design tool might even modify the shape of the cab. Other examples: In its materials business, General Electric provides Web-based tools that customers use for designing better plastics products. Likewise, many software companies encourage users to add custom-designed modules to their standard products and then commercializes the best of those components.49 Determinants of New Product Performance and Timeliness What factors are most important in determining the success or failure of the new product? Why are some firms faster than others in moving projects through the development process? Let’s review the available evidence. The Determinants of Success Both strategic factors and a firm’s proficiency in carrying out the new-productdevelopment process determine new product success.50 Strategic Factors Research suggests that four strategic factors appear to be crucial to new product success. The level of product advantage is the most important. Product advantage refers to customer perceptions of product superiority with respect to quality, cost–performance ratio, or function relative to competitors. Successful products offer clear benefits, such as reduced customer costs, and are of higher quality (for example, more durable) than competitors’ products. A study of more than 100 new product projects in the chemical industry illustrates the point. Here, Robert Cooper and Elko Kleinschmidt assert, “The winners are new products that offer high relative product quality, have superior price/performance characteristics, provide good value for the money to the customer, are superior to competing products in meeting customer needs, [and] have unique attributes and highly visible benefits that are easily seen by the customer.”51 Marketing synergy and technical synergy are also pivotal in new product outcomes. Marketing synergy is the fit between the needs of the project and the firm’s 49Stephen Thomke and Eric von Hippel, “Customers as Innovators: A New Way to Create Value,” Harvard Business Review 80 (April 2002): pp. 74–81. 50Mitzi M. Montoya-Weiss and Roger Calantone, “Determinants of New Product Performance: A Review and Meta- Analysis,” Journal of Product Innovation Management 11 (November 1994): pp. 397–417; see also Robert G. Cooper, Scott J. Edgett, and Elko J. Kleinschmidt, “Benchmarking Best NPD Practices–III,” Research Technology Management 47 (November–December 2004): pp. 43–55. 51Robert G. Cooper and Elko J. Kleinschmidt, “Major New Products: What Distinguishes the Winners in the Chemical Industry?” Journal of Product Innovation Management 10 (March 1993): p. 108; see also Tiger Li and Roger J. Calantone, “The Impact of Market Knowledge Competence on New Product Advantage: Conceptualization and Empirical Examination,” Journal of Marketing 62 (October 1998): pp. 13–29. 252 Part IV Formulating Business Marketing Strategy resources and skills in marketing (for example, personal selling or market research). By contrast, technical synergy concerns the fit between the needs of the project and the firm’s R&D resources and competencies. New products that match the skills of the firm are likely to succeed. In addition to the preceding three factors, an international orientation also contributes to the success of product innovation.52 New products designed and developed to meet foreign requirements and targeted at world or nearest-neighbor export markets outperform domestic products on almost every measure, including success rate, profitability, and domestic and foreign market shares. Underlying this success is a strong international focus in market research, product testing with customers, trial selling, and launch efforts. Development Process Factors New product success is also associated with particular characteristics of the development process. Predevelopment proficiency provides the foundation for a successful product. Predevelopment involves several important tasks such as initial screening, preliminary market and technical assessment, detailed market research study, and preliminary business/financial analysis. Firms that are skilled in completing these upfront tasks are likely to experience new product success. Market knowledge and marketing proficiency are also pivotal in new product outcomes. As might be expected, business marketers with a solid understanding of market needs are likely to succeed. Robert Cooper describes the market planning for a successful product he examined: “Market information was very complete: there was a solid understanding of the customer’s needs, wants, and preferences; of the customer’s buying behavior and price sensitivity; of the size and trends of the market; and of the competitive situation. Finally, the market launch was well planned, well targeted, proficiently executed, and backed by appropriate resources.”53 Technical knowledge and technical proficiency are other important dimensions of the new-product-development process. When technical developers have a strong base of knowledge about the technical aspects of a potential new product, and when they can proficiently pass through the stages of the new-product-development process (for example, product development, prototype testing, pilot production, and production start-up), these products succeed. Fast-Paced Product Development Rapid product development offers a number of competitive advantages. To illustrate, speed enables a firm to respond to rapidly changing markets and technologies. Moreover, fast product development is usually more efficient because lengthy development processes tend to waste resources on peripheral activities and changes.54 Of course, although an overemphasis on speed may create other pitfalls, it is becoming an important strategic weapon, particularly in high-technology markets. 52Elko J. Kleinschmidt and Robert G. Cooper, “The Performance Impact of an International Orientation on Product Innovation,” European Journal of Marketing 22 (9, 1988): pp. 56–71. 53Robert G. Cooper, Winning at New Products: Accelerating the Process from Idea to Launch (Reading, Mass: Addison-Wesley, 1993), p. 27; see also Robert G. Cooper, “Perspective: The Stage-Gate® Idea to Launch Process—Update, What’s New, and NextGen Systems,” Journal of Product Innovation Management 25 (May 2008): pp. 213–232. 54See, for example, Robert G. Cooper and Elko J. Kleinschmidt, “Determinants of Timeliness in Product Development,” Journal of Product Innovation Management 11 (November 1994): pp. 381–417. Chapter 9 Managing Innovation and New Industrial Product Development 253 Matching the Process to the Development Task How can a firm accelerate product development? A major study of the global computer industry provides some important benchmarks.55 Researchers examined 72 product development projects of leading U.S., European, and Asian computer firms. The findings suggest that multiple approaches are used to increase speed in product development. Speed comes from properly matching the approach to the product development task at hand. Compressed Strategy for Predictable Projects For well-known markets and technologies, a compression strategy speeds development. This strategy views product development as a predictable series of steps that can be compressed. Speed comes from carefully planning these steps and shortening the time it takes to complete each one. This research indicates that the compressed strategy increased the speed of product development for products that had predictable designs and that were targeted for stable and mature markets. Mainframe computers fit into this category—they rely on proprietary hardware, have more predictable designs from project to project, and compete in a mature market. Experiential Strategy for Unpredictable Projects For uncertain markets and technologies, an experiential strategy accelerates product development. The underlying assumption of this strategy, explain Kathleen Eisenhardt and Behnam Tabrizi, is that “product development is a highly uncertain path through foggy and shifting markets and technologies. The key to fast product development is, then, rapidly building intuition and flexible options in order to learn quickly about and shift with uncertain environments.”56 Under these conditions, speed comes from multiple design iterations, extensive testing, frequent milestones, and a powerful leader who can keep the product team focused. Here real-time interactions, experimentation, and flexibility are essential. The research found that the experiential strategy increased the speed of product development for unpredictable projects such as personal computers—a market characterized by rapidly evolving technology and unpredictable patterns of competition. Summary Product innovation is a high-risk and potentially rewarding process. Sustained growth depends on innovative products that respond to existing or emerging consumer needs. Effective managers of innovation channel and control its main directions but have learned to stay flexible and expect surprises. Within the firm, marketing managers pursue strategic activity that falls into two broad categories: induced and autonomous strategic behavior. New-product-development efforts for existing businesses or market-development projects for the firm’s present products are the outgrowth of induced strategic initiatives. In contrast, autonomous strategic efforts take shape outside the firm’s current concept of strategy, depart from the current course, and center on new categories of business opportunity; middle managers initiate the project, champion its development, and, if successful, see the project integrated into the firm’s concept of strategy. 55Kathleen M. Eisenhardt and Behnam N. Tabrizi, “Accelerating Adaptive Processes: Product Innovation in the Global Computer Industry,” Administrative Science Quarterly 40 (March 1995): pp. 84–110. 56Ibid., p. 91. 254 Part IV Formulating Business Marketing Strategy Corporate entrepreneurs thrive in a culture where senior managers promote and reward innovative behavior, encourage risk-taking, and provide the administrative mechanisms to screen, develop, and implement new product ideas. The long-run competitive position of most business marketing firms depends on their ability to manage and increase their technological base. Core competencies provide the basis for products and product families. Each generation of a product family has a platform that serves as the foundation for specific products targeted at different or complementary market applications. Because companies keep working to make better products, they can sell at higher profit margins to the most demanding customers, and they often overshoot the needs of mainstream customers. A sustaining innovation provides demanding high-end customers with improved performance, whereas disruptive innovations target new or less-demanding customers with an easy-to-use, less-expensive alternative that is “good enough.” Disruptive strategies take two forms: low-end and new-market disruptions. Firms that are successful innovators in turbulent markets combine limited structures (for example, priorities, deadlines) with extensive communication and the freedom to improvise on current projects. These successful product creators also explore the future by experimenting with a variety of low-cost probes and build a relentless sense of urgency in the organization by creating new products at predictable time intervals (i.e., time pacing). Effective new product development requires a thorough knowledge of customer needs and a clear grasp of the technological possibilities. Lead user analysis and customer visits often uncover valuable new product opportunities. Top-performing firms execute the new-product-development process proficiently, provide adequate resources to support new product objectives, and develop clear new product strategy. Both strategic factors and the firm’s proficiency in executing the new-product-development process are critical to the success of industrial products. Fast-paced product development can provide an important source of competitive advantage. Speed comes from adapting the process to the new-product-development task at hand. Discussion Questions 1. Research by James Quinn suggests that few major innovations result from highly structured planning systems. What does this imply for the business marketer? 2. Compare and contrast induced and autonomous strategic behavior. Describe the role of the product champion in the new-productdevelopment process. 3. The breakthrough products for many companies did not emerge from the formal new-product-development process. Instead, they were championed by a few resourceful employees. What steps can organizations take to motivate and support corporate entrepreneurship? 4. Compare and contrast a low-end versus a new-market disruptive strategy. 5. In many markets, a new entrant might consider a strategy that provides potential customers with a product or technology that is “good enough” Chapter 9 Managing Innovation and New Industrial Product Development 255 rather than “superior” to existing options. Describe the key tests that a disruptive strategy must pass in order to stack the odds for success in its favor. 6. In fast-changing high-tech industries, some firms have a better record in developing new products than others. Describe the critical factors that drive the new product performance of firms. 7. Rather than planning for and investing in just one version of the future, some firms use low-cost probes to experiment with many possible futures. Evaluate the wisdom of this approach. 8. Describe how Marriott might employ lead user analysis to better align its properties and services with the needs of the executive traveler. 9. New industrial products that succeed provide clear-cut advantages to customers. Define product advantage and provide an example of a recent new product introduction that fits this definition. 10. Evaluate this statement: “To increase the speed of the new-productdevelopment process, a firm might follow one strategy for unpredictable projects and an entirely different one for more predictable ones.” Internet Exercise 1. Years ago, Corning sold dishes and glassware in the consumer market. Today, the firm might be characterized as a high-tech material science company that competes successfully in an array of business markets. Go to http://www.corning.com and identify its major product lines. 256 Part IV Formulating Business Marketing Strategy CASE Steelcase Inc. Extends Reach to Growing Health-Care Market Steelcase, a leading office furniture manufacturer, launched a new health-care-focused subsidiary called Nurture. James P. Hackett, president and CEO of Steelcase, had assigned a team to study the health care market, and here is what they concluded: We should move into the health-care market by launching a new health care brand. It would expand our current effort “on carpet”—work areas in hospitals that are like the office spaces (nurses’ stations, for instance)—but we would also expand “off carpet”—to entirely different areas of the hospital (patients’ rooms, examining rooms, café lounges). . . . The brand would draw on technology and products we already had, as well as new products we would manufacture and new customizing services we would provide.57 The team got the go-ahead from senior management to launch the new business unit and the Nurture brand. Given that the cost of hospital care is expected to exceed $1.2 trillion by 2016, Steelcase executives saw the health-care market as a golden opportunity.58 They were also encouraged to learn that the highest sales volume for the company’s Criterion chair—a classic desk seat with adjustable back tension, lumbar-curve support, and wrist rests—was going to health-care customers—hospitals, clinics, and doctors’ offices. John Carlson, vice president of product development and marketing at Nurture, believes that the unit can enjoy a competitive advantage by offering cohesive suites of examination tables, patient beds, nurses’ stations, and the like. However, there are some formidable competitors that have deep knowledge of health-care customers, like Hill-Rom, a unit of Hillenbrand Industries. A leading manufacturer of hospital beds, Hill-Rom also offers a limited collection of furniture selections but has been squarely centered on the health-care market for decades and has forged close and enduring relationships with physicians, nurses, and administrators at health-care facilities, large and small. Discussion Question 1. To develop patient-friendly furnishings or suites of products that boost staff productivity, describe specific steps that marketing strategists at Nurture might take to learn more about the workings of a hospital environment and the needs of different constituents—patients, visitors, nurses, and physicians. 57James P. Hackett, “Preparing for the Perfect Launch,” Harvard Business Review 85 (April 2007): p. 49. 58Reena Jana, “Steelcase’s Medical Breakthrough,” March 22, 2007, accessed at http://www.businessweek.com on July 14, 2008. 256 CHAPTER 10 Managing Services for Business Markets The important and growing market for business services poses special challenges and meaningful opportunities for the marketing manager. This chapter explores the unique aspects of business services and the special role they play in the business market environment. After reading this chapter, you will understand: 1. the value of systematically monitoring the customer experience and the central role that business services assume in customer solutions. 2. the roles that service quality, customer satisfaction, and loyalty assume in service market success. 3. significant factors to consider in formulating a service marketing strategy. 4. the determinants of new service success and failure. 257 258 Part IV Formulating Business Marketing Strategy FedEx Corporation, the global package delivery service, mobilizes for trouble before it occurs: Each night, five empty FedEx jets roam over the United States.1 Why? So the firm can respond on a moment’s notice to unexpected events such as overbooking of packages in Atlanta or an equipment failure in Denver. FedEx excels by making promises to its customers and keeping them. The first major service organization to win the Malcolm Baldrige National Quality Award, FedEx makes specific promises about the timeliness and reliability of package delivery in its advertising and marketing communications. More importantly, FedEx aligns its personnel, facilities, information technology, and equipment to meet those promises. Says Scot Struminger, vice president of information technology at FedEx, “We know that customer loyalty comes from treating customers like you want to be treated.”2 As this example demonstrates, services play a critical role in the marketing programs of many business-to-business firms, whether their primary focus is on a service (FedEx) or whether services provide a promising new path for growth. Indeed, hightech brands, like IBM or Hewlett-Packard, are built on a promise of value to customers, and service excellence is part of the value package customers demand. In fact, over half of IBM’s massive revenue base now comes from services—not products. Clearly, many product manufacturers are now using integrated product and service solutions as a core marketing strategy for creating new growth opportunities; moreover, a vast array of “pure service” firms exist to supply organizations with everything from office cleaning to management consulting and just-in-time delivery to key customers.3 This chapter examines the nature of business services, the key buying behaviors associated with their purchase, the major strategic elements related to services marketing, and the new-service-development process. Understanding the Full Customer Experience The traditional product-centric mindset rests on the assumption that companies win by creating superior products and continually enhancing the performance of existing products. But services are fundamental to the customer experience that every business-to-business firm provides. Customer experience encompasses every dimension of a company’s offering—product and service features, advertising, ease of use, reliability, the process of becoming a customer, or the way problems are resolved— not to mention the ongoing sales relationship.4 The Customer Experience Life Cycle Recent research highlights the importance of examining the customer’s experience. A survey of the customers of 362 firms by Bain & Company revealed that only 1David Leonhardt, “The FedEx Economy,” New York Times, October 8, 2005, p. B1. 2Don Peppers and Martha Rogers, Return on Customer: Creating Maximum Value from Your Scarcest Resource (New York: Currency Doubleday, 2005), p. 144. 3Kristian Möller, Risto Rajala, and Mika Westerlund, “Service Innovation Myopia? A New Recipe for Client-Provider Value Creation,” California Management Review 50 (Spring 2008): pp. 31–48. 4Christopher Meyer and Andre Schwager, “Understanding Customer Experiences,” Harvard Business Review 85 (February 2007): pp. 116–127. Chapter 10 Managing Services for Business Markets FIGURE 10.1 259 THE FIRST STEP IN UNDERSTANDING A CUSTOMER’S EXPERIENCE IS TO DEVELOP A LIFE CYCLE MAP A representative set of customer-company interactions Relationship initiation Provider evaluation Account setup Product reception and use Order placement Problem resolution Payment Account maintenance The company exposes the customer to its marketing message The customer gets initial price and lead-time quotes The customer obtains materials for account setup The customer selects the product The customer tracks order status The customer files a claim and obtains resolution The customer receives and validates the invoice The customer maintains profile information The customer seeks relevant information The customer puts out an RFP The customer provides account profile information The customer places the order (fills out the order form) The company and the customer arrange the final delivery terms The customer The customer notifies the company makes the payment of a problem and obtains resolution The customer maintains supplies The customer evaluates providers and negotiates terms and pricing The company confirms setup and activation The customer receives and inspects the product The customer seeks an invoice adjustment and obtains resolution The customer selects the provider The company performs courtesy follow-up The customer prepares specialty documents when required (for example, for rush delivery) The customer requests product information The company and the customer arrange initial delivery terms The customer refuses or accepts the product The company provides general support (not related to problems) The customer obtains ongoing price quotes SOURCE: David Rickard, “Winning by Understanding the Full Customer Experience,” The Boston Consulting Group, Inc., 2007, p. 6. Accessed on July 26, 2008 at http://www.bcg.com. All rights reserved. Reproduced by permission. 8 percent described their experience as “superior,” yet 80 percent of the companies surveyed believed that the experience that they were delivering was indeed superior.5 By focusing narrowly only on core-related product elements and overlooking the full customer experience, companies “can end up losing customers without understanding why. Moreover, such companies are missing out on some powerful opportunities to create value and cement their customers’ loyalty,” says David Rickard, vice president, The Boston Consulting Group.6 Customer experience represents the internal and subjective response a business customer has to any direct or indirect contact with a company. We will devote special attention to touchpoints—those instances where the customer has direct contact with either the product or service itself or with representatives of it by a third party, such as a channel partner. A customer experience map provides a valuable tool for diagnosing key touchpoints or interactions between the company and the customer from the moment contact is made with a potential customer through the maintenance of an ongoing relationship (see Figure 10.1). Developed from interviews with customers, the map provides a foundation for defining what’s most important in your customers’ experience. 5Ibid., p. 117. 6David Rickard, “Winning by Understanding the Full Customer Experience,” The Boston Consulting Group, Inc., 2006, p. 1, accessed at http://www.bcg.com on May 15, 2008. 260 Part IV Formulating Business Marketing Strategy Applying the Customer Experience Map The map was developed by the Boston Consulting Group for a large industrial-goods company that faced this dilemma: Traditional measures of product quality continued to indicate superb performance, but customer satisfaction remained stagnant and the company was losing market share.7 Once the customer experience map is developed, the next step is to meet with customers and pare down the list to a smaller set of the most critical interactions and product and service characteristics. The ultimate goal of the analysis is to identify (1) the value that customers place on different levels of performance (for example, high, average, low) for each element of their experience, (2) the customers’ minimal expectations for each element, and (3) the customers’ perception of the firm’s performance versus that of key competitors. Based on the analysis, strategists at the industrial-goods company were surprised to learn that only 40 percent of customers’ most critical experiences were tied to the core product, whereas 60 percent were related to softer considerations (for example, the ease of making invoice corrections and resolving problems). This revelation proved crucial to understanding why the company was losing market share even though its customers’ ratings of product quality were improving. Customer Experience Management Recall from Chapter 4 that customer relationship management captures what a company knows about a particular customer. Christopher Meyer and Andre Schwager persuasively argue that there is a corresponding need for well-developed customer experience management processes that capture customers’ subjective thoughts about a particular company.8 Such an approach requires surveys and targeted studies at points of customer interaction that identify gaps between customer expectations and their actual experience. “Because a great many customer experiences aren’t the direct consequence of the brand’s message or the company’s actual offerings . . . the customers themselves . . . must be monitored and probed.”9 A Solution-Centered Perspective10 As global competition intensifies and product differentiation quickly fades, strategists at leading firms from General Electric and IBM to Staples and Home Depot are giving increased attention to services, particularly a solution-centric mindset. Rather than starting with the product, a solution-centered approach begins with an analysis of a customer problem and ends by identifying the products and services required to solve the problem. Rather than transaction based, the focus of the exchange process is interaction based, and value is co-created by the firm in concert with the customer (Table 10.1). So, customer offerings represent an “integrated combination of products and services designed to provide customized experiences for specific customer segments.”11 Services, as a critical feature of the solution, become a valuable basis for competitive advantage and an important driver of profitability. 7This illustration is based on Rickard, ibid., p. 5. 8Meyer and Schwager, “Understanding Customer Experiences.” 9Ibid., p. 116. 10Except where noted, this section draws on Mohanbir Sawhney, “Going Beyond the Product: Defining, Designing, and Delivering Customer Solutions,” Working Paper, Kellogg School of Management, Northwestern University, December 2004, pp. 1–10. 11Ibid., p. 4. Chapter 10 Managing Services for Business Markets TABLE 10.1 261 FROM A PRODUCT TO A SOLUTIONS PERSPECTIVE Value Proposition Value Creation Product Perspective Solutions Perspective Win by creating innovative products and enriching features of existing products Value is created by the firm Win by creating and delivering superior customer solutions Designing Offerings Start with the product or service, and then target customer segments Company-Customer Relationship Transaction-based Focus on Quality Quality of internal processes and company offerings Value is co-created by the customer and the firm Start with the customer problem, and then assemble required products and services to solve the problem Interaction-based and centered on the co-creation of solutions Quality of customer–firm interactions SOURCE: Adapted from Mohanbir Sawhney, “Going Beyond the Product: Defining, Designing, and Delivering Customer Solutions,” Working Paper, Kellogg School of Management, Northwestern University, December 2004; and C. K. Prahalad and Venkat Ramaswamy, The Future of Competition: Co-Creating Unique Value with Customers (Boston: Harvard Business School Press, 2004). UPS Solutions United Parcel Services of America began by mastering a narrow set of activities involved in the package delivery system—picking up, shipping, tracking, and delivering packages. Adopting a solution-centered focus, UPS tapped new market opportunities:12 • Designing transportation networks that reduced the time Ford needed to deliver vehicles from its plants to dealers by up to 40 percent; • Managing the movement of National Semiconductor’s products from its manufacturing plants to customers around the world and helping the customer reduce shipping and inventory costs by 15 percent; • Partnering with Nike and managing all the back-office processes for direct selling from order management and delivery to customer support. Determine Unique Capabilities In developing solutions, business marketing firms must define their unique capabilities and determine how to use them to help customers reduce costs, increase responsiveness, or improve quality. In some cases, this may involve taking in some of the work or activities that customers now perform. To illustrate, DuPont first sold paint to Ford but now runs Ford’s paint shops. “DuPont, which is paid on the basis of the number of painted vehicles, actually sells less paint than before because it has an incentive to paint cars with the least amount of waste. But the company makes more money as a result of the improved efficiency.”13 The 12Mohanbir Sawhney, Sridhar Balasubramanian, and Vish V. Krishnan, “Creating Growth with Services,” MIT Sloan Management Review 45 (Winter 2004): pp. 34–43. 13Ibid., p. 39. 262 Part IV Formulating Business Marketing Strategy INSIDE BUSINESS MARKETING Do Service Transition Strategies Pay Off ? To improve their competitive position in the era of intense global competition and the increasing commoditization that characterizes many product markets, a host of manufacturing firms have added services to their existing product offerings. If successful, such service transition strategies could make the firm’s value proposition more unique, difficult for rivals to duplicate, and valuable to customers, thereby enhancing profitability and firm value. Do these service transition strategies pay off ? A recent study by Eric Fang and his colleagues provides the answers. • Before they can expect positive effects on firm value, business marketing firms should recognize that service transition strategies typically require achieving a critical mass in sales, estimated to be 20 to 30 percent of total sales. • Transitioning to services is significantly more effective for companies that offer services related to their core product business. Sales of unrelated services demonstrate little impact on firm value. • Adding services to a core product offering increases firm value for companies in slow growth and turbulent industries. However, “firms in high growth industries can destroy firm value by shifting their focus . . . to service initiatives. In stable (low turbulence) industries, adding services has a negative effect on firm value. . . .” SOURCE: Eric (Er) Fang, Robert W. Palmatier, and Jan-Benedict E. M. Steenkamp, “Effect of Service Transition Strategies on Firm Value,” Journal of Marketing, forthcoming. DuPont example demonstrates a central point about solutions marketing: Products provide the platform for the delivery of services.14 A recent research study suggests that companies can deliver more effective solutions at profitable prices if they adopt a stronger relationship focus.15 The authors suggest that business marketers mistakenly view a solution as a customized and integrated combination of products and services for meeting a customer’s business needs. In sharp contrast, customers view a solution as a set of customer–company relational processes that involve “(1) customer requirements definition, (2) customization and integration of goods and/or services and (3) their deployment, and (4) postdeployment customer support, all of which are aimed at meeting customers’ business needs.”16 Once again, this highlights the importance of moving beyond a mere focus on transactions to consider the full set of customer experiences. Benefits of Solution Marketing By shifting from a product to a solutions strategy, business-to-business firms gain two important benefits, namely, new avenues for growth and differentiation. Creating Growth Opportunities Solutions create fresh opportunities for increasing the amount of business or share-of-wallet that a company receives from its customer base. An expanded portfolio of service-intensive offerings makes this possible. Often, services represent a far larger market opportunity than the core product market. 14Stephen L. Vargo and Robert F. Lusch, “Evolving to a New Dominant Logic for Marketing,” Journal of Marketing 68 (January 2004): pp. 1–18. 15Kapil R. Tuli, Ajay K. Kohli, and Sundar R. Bharadwaj, “Rethinking Customer Solutions for Product Bundles to Relational Process,” Journal of Marketing 71 (July 2007): pp. 1–17. 16Ibid., p. 1. Chapter 10 Managing Services for Business Markets 263 To illustrate, Deere & Company, the agricultural equipment manufacturer, found that the proportion of each dollar farmers spend on equipment has been declining for years and that the bulk of that spending now goes for services. Moreover, by centering on that profit pool, Deere is tapping into a market opportunity that is 10 times larger than the equipment market. To that end, Deere provides a range of services for its customers (for example, health insurance and banking) and is employing innovative technologies to make the farmer’s life easier and more productive. For example, Deere is experimenting with global positioning systems (GPS) and biosensors on its combines. C. K. Prahalad and Venkat Ramaswamy describe the initiative: Imagine driverless combines and tractors with onboard sensors that can measure the oil content of grain or distinguish between weeds and crops. The benefits are enormous. Farmers can ration herbicide according to soil conditions. GPS-guided steering ensures repeatable accuracy, eliminates overtreating of crops . . . thereby reducing time, fuel, labor, and chemical costs. . . . Farmers can be more productive, minimizing the cost per acre.17 Sustaining Differentiation and Customer Loyalty As farmers view more and more products as commodities, business marketers who emphasize solutions can sustain differentiation more effectively than rivals who maintain a strict focus on the core product offering. Why? According to Mohanbir Sawhney, “Solutions offer many more avenues for differentiation than products because they include a variety of services that can be customized in many unique ways for individual customers.”18 Likewise, by developing a rich network of relationships with members of the customer organization, co-creating solutions with the customer, and becoming directly connected to the customer’s operations, they enhance customer loyalty and throw up severe barriers to competing firms when they attempt to persuade the customer to switch suppliers. Business Service Marketing: Special Challenges The development of marketing programs for both products and services can be approached from a common perspective; yet the relative importance and form of various strategic elements differ between products and services. The underlying explanation for these strategic differences, asserts Henry Assael, lies in the distinctions between a product and a service: Services are intangible; products are tangible. Services are consumed at the time of production, but there is a time lag between the production and consumption of products. Services cannot be stored; products can. Services are highly variable; most products are highly standardized. These differences produce differences in strategic applications that often stand many product marketing principles on their head.19 17C. K. Prahalad and Venkat Ramaswamy, The Future of Competition: Co-Creating Unique Value with Customers (Boston: Harvard Business School Press, 2004), pp. 93–94. 18Mohanbir Sawhney, “Going Beyond the Product,” p. 6. 19Henry Assael, Marketing Management: Strategy and Action (Boston.: Kent Publishing, 1985), p. 693. 264 Part IV Formulating Business Marketing Strategy FIGURE 10.2 Tangible Dominant BUSINESS PRODUCT—SERVICE CLASSIFICATION BASED ON TANGIBILITY Oil and Grease Office Supplies Machinery Personal Computers Telecommunications Systems Meeting or Convention Hotel Meeting or Convention Hotel Advertising Agencies Plant Janitorial and Cleaning Freight Transportation Management Consulting Executive Management Seminars Intangible Dominant SOURCE: Adapted from G. Lynn Shostack, “Breaking Free from Product Marketing,” Journal of Marketing 41 (April 1977): p. 77. Published by the American Marketing Association. Thus, success in the business service marketplace begins with understanding the meaning of service. Services Are Different There are inherent differences between goods and services, providing a unique set of marketing challenges for service businesses and for manufacturers that provide services as a core offering. Put simply, services are deeds, processes, and performances.20 For example, a management consultant’s core offerings are primarily deeds and actions performed for customers. The most basic, and universally recognized, difference between goods and services is intangibility. Services are more intangible than manufactured goods, and manufactured goods are more tangible than services. Because services are actions or performances, they cannot be seen or touched in the same way that consumers sense tangible goods. Tangible or Intangible? Figure 10.2 provides a useful tool for understanding the product–service definitional problem. The continuum suggests that there are very few pure products or pure services. For example, a personal computer is a physical object made up of tangible elements that facilitate the work of an individual and an organization. In addition to the computer’s physical design and performance characteristics, the quality of technical service support is an important dimension of the marketing program. Thus, most market offerings comprise a combination of tangible and intangible elements. Whether an offering is classified as a good or as a service depends on how the organizational buyer views it—whether the tangible or the intangible elements dominate. On one end of the spectrum, grease and oil are tangible-dominant; the essence of what is being bought is the physical product. Management seminars, on the other 20Valarie A. Zeithaml, Mary Jo Bitner, and Dwayne D. Gremler, Services Marketing: Integrating Customer Focus across the Firm, 5th ed. (Boston: McGraw-Hill Irwin, 2009), p. 2. Chapter 10 Managing Services for Business Markets 265 hand, are intangible-dominant because what is being bought—professional development, education, learning—has few, if any, tangible properties. A convention hotel is in the middle of the continuum because the buyer receives an array of both tangible elements (meals, beverages, notepads, and so on) and intangible benefits (courteous personnel, fast check-ins, meeting room ambiance, and so forth). The concept of tangibility is especially useful to the business marketer because many business offerings are composed of product and service combinations. The key management task is to evaluate carefully (from the buyer’s standpoint) which elements dominate. The more the market offering is characterized by intangible elements, the more difficult it is to apply the standard marketing tools that were developed for products. The business marketer must focus on specialized marketing approaches appropriate for services. The concept of tangibility also helps the manager focus clearly on the firm’s total market offering.21 In addition, it helps the manager recognize that a change in one element of the market offering may completely change the offering in the customer’s view. For example, a business marketer who decides to hold spare-parts inventory at a central location and use overnight delivery to meet customer requirements must refocus marketing strategy. The offering has moved toward the intangible end of the continuum because of the intangible benefits of reduced customer inventory and fast transportation. This new “service,” which is less tangible, must be carefully explained, and the intangible results of lower inventory costs must be made more concrete to the buyer through an effective promotion program. In summary, business services are market offerings that are predominantly intangible. However, few services are totally intangible—they often contain elements with tangible properties. In addition to tangibility, business services have other important distinguishing characteristics that influence how they are marketed. Table 10.2 summarizes the core characteristics that further delineate the nature of business services. Simultaneous Production and Consumption Because services are generally consumed as they are produced, a critical element in the buyer-seller relationship is the effectiveness of the individual who actually provides the service—the IBM technician, the UPS driver, the McKinsey consultant. From the service firm’s perspective, the entire marketing strategy may rest on how effectively the individual service provider interacts with the customer. Here the actual service delivery takes place and the promise to the customer is kept or broken. This critical point of contact with the customer is referred to as interactive or real-time marketing. Recruiting, hiring, and training personnel assume special importance in business service firms. Service Variability Observe in Table 10.2 that service is nonstandardized, meaning that the quality of the service output may vary each time it is provided.22 Services vary in the amount of 21Arun Sharma, R. Krishnan, and Dhruv Grewal, “Value Creation in Markets: A Critical Area of Focus for Business-to- Business Markets,” Industrial Marketing Management 30 (June 2001): pp. 391–402. 22 Valarie A. Zeithaml, A. Parasuraman, and Leonard R. Berry, “Problems and Strategies in Services Marketing,” Journal of Marketing 49 (Spring 1985): p. 34; see also Zeithaml, Berry, and Parasuraman, “Communication and Control Processes in the Delivery of Service Quality,” Journal of Marketing 52 (April 1988): pp. 35–48. 266 Part IV Formulating Business Marketing Strategy TABLE 10.2 UNIQUE SERVICE CHARACTERISTICS Characteristics Examples Marketing Implications Simultaneous production and consumption Telephone conference call; management seminar; equipment repair Nonstandardized output Management advice varies with the individual consultant; merchandise damages vary from shipment to shipment Perishability: inability to store or stockpile Unfilled airline seats; an idle computer technician; unrented warehouse space Lack of ownership Use of railroad car; use of consultant’s know-how; use of mailing list Direct-seller interaction requires that service be done “right”; requires highlevel training for personnel; requires effective screening and recruitment Emphasizes strict quality control standards; develop systems that minimize deviation and human error; prepackage the service; look for ways to automate Plan capacity around peak demand; use pricing and promotion to even out demand peaks and valleys; use overlapping shifts for personnel Focus promotion on the advantages of nonownership: reduced labor, overhead, and capital; emphasize flexibility equipment and labor used to provide them. For example, a significant human element is involved in teaching an executive seminar compared with providing overnight airfreight service. Generally, the more labor involved in a service, the less uniform the output. In these labor-intensive cases, the user may also find it difficult to judge the quality before the service is provided. Because of uniformity problems, business service providers must focus on finely tuned quality-control programs, invest in “systems” to minimize human error, and seek approaches for automating the service. Service Perishability Generally, services cannot be stored; that is, if they are not provided at the time they are available, the lost revenue cannot be recaptured. Tied to this characteristic is the fact that demand for services is often unpredictable and widely fluctuating. The service marketer must carefully evaluate capacity—in a service business, capacity is a substitute for inventory. If capacity is set for peak demand, a “service inventory” must exist to supply the highest level of demand. As an example, some airlines that provide air shuttle service between New York, Washington, and Boston offer flights that leave every hour. If, on any flight, the plane is full, another plane is brought to the terminal—even for one passenger. An infinite capacity is set so that no single business traveler is dissatisfied. Obviously, setting high capacity levels is costly, and the marketer must analyze the cost versus the lost revenue and customer goodwill that might result from maintaining lower capacity. Nonownership The final dimension of services shown in Table 10.2 is that the service buyer uses, but does not own, the service purchased. Essentially, payment for a service is a payment for the use of, access to, or hire of items. Renting or leasing is “a way for customers to enjoy use of physical goods and facilities that they cannot afford to buy, cannot justify Chapter 10 Managing Services for Business Markets 267 INSIDE BUSINESS MARKETING To Sell Jet Engines, Teach Your Customer How to Sell Aircraft A major segment of GE Transportation is the General Electric Aircraft Engines division. This unit is the world’s largest manufacturer of jet engines, ranging from small 14,000-pound thrust engines up to the giant GE90, a 115,000-pound thrust engine that powers the Boeing 777. As important as these engines are to GE’s profitability, the real profits come from the service package surrounding the sale of an engine. A jet engine lasts years, and what often clinches a sale and leads to long-term profits for GE is the full-service “package” that accompanies the engine over its lifespan. One GE marketing manager claims that “jet engines are almost commodities; the key differentiator is the lifetime service we offer our customers.” Interestingly, the airline that buys a new aircraft is generally the decision-making unit that chooses the engine brand to be installed—not the aircraft manufacturer, namely Boeing or Airbus. Recognizing the importance of the airline in the purchase process for jet engines, GE embarked on a creative strategy. Several new aircraft manufacturers began operations in China in the early 2000s as a result of that country’s major economic growth. One manufacturer, specializing in small, regional jets (50- to 70-passenger capacity), selected GE as the engine supplier in 2004, although the firm would not produce an airplane until at least 2008. The company was starting from scratch when it selected GE engines for its planes. GE immediately began working with the firm to refine the plane’s design and engineering, and these valuable services were one reason it selected GE as the supplier. More importantly, GE assigned one manager and a team of sales, engineering, and marketing specialists to work with the firm. One of GE’s first efforts was to bring 25 sales and marketing managers from the Chinese aircraft company to the United States for two weeks of training. These managers represent the personnel who will be selling the aircraft to airline executives in China, as well as in many other parts of the world. The two-week training program centered on the basics of business-tobusiness marketing—something the Chinese knew little about. GE brought in experienced faculty to teach the Chinese and provided GE managers to follow up on the training at later dates. What is unique about this approach is that a supplier was actually teaching the customer how to market and sell! Of course, the benefits to GE are huge: If the Chinese aircraft firm is effective at business-tobusiness selling to airlines, then more GE engines will be demanded in the future. purchasing, or prefer not to retain after use.”23 The service marketer must feature the advantages of nonownership in its communications to the marketplace. The key benefits to emphasize are reductions in staff, overhead, and capital from having a third party provide the service. Although there may be exceptions, these characteristics provide a useful framework for understanding the nature of business services and isolating special marketing strategy requirements. The framework suggests that different types of service providers should pursue different types of strategies because of the intangibility and heterogeneity of their services. In this case, providers of professional services (consulting, tax advising, accounting, and so on) should develop marketing strategies that emphasize word-of-mouth communication, provide tangible evidence, and employ value pricing to overcome the issues created by intangibility and heterogeneity.24 23 Christopher Lovelock and Evert Gummesson, “Whither Services Marketing? In Search of a New Paradigm and Fresh Perspectives,” Journal of Services Research 7 (August 2004): p. 36. 24 Michael Clemes, Diane Mollenkopf, and Darryl Burn, “An Investigation of Marketing Problems across Service Typologies,” Journal of Services Marketing 14 (no. 6–7, 2000): p. 568; see also, Möllar, Rajala, and Westerlund, “Service Innovation Myopia,” pp. 34–46. 268 Part IV Formulating Business Marketing Strategy Service Quality Quality standards are ultimately defined by the customer. Actual performance by the service provider or the provider’s perception of quality are of little relevance compared with the customer’s perception. “Good” service results when the service provider meets or exceeds the customer’s expectations.25 As a result, many management experts argue that service companies should carefully position themselves so that customers expect a little less than the firm can actually deliver. The strategy: underpromise and overdeliver. Dimensions of Service Quality Because business services are intangible and nonstandardized, buyers tend to have greater difficulty evaluating services than evaluating goods. Because they are unable to depend on consistent service performance and quality, service buyers may perceive more risk.26 As a result, they use a variety of prepurchase information sources to reduce risk. Information from current users (word of mouth) is particularly important. In addition, the evaluation process for services tends to be more abstract, more random, and more heavily based on symbology rather than on concrete decision variables.27 Research provides some valuable insights into how customers evaluate service quality. From Table 10.3, note that customers focus on five dimensions in evaluating service quality: reliability, responsiveness, assurance, empathy, and tangibles. Among these dimensions, reliability—delivery on promises—is the most important to customers. High-quality service performance is also shaped by the way frontline service personnel provide it. To the customer, service quality represents a responsive employee, one who inspires confidence, and one who adapts to the customer’s unique needs or preferences and delivers the service in a professional manner. In fact, the performance of employees who are in contact with the customer may compensate for temporary service quality problems (for example, a problem reoccurs in a recently repaired photocopier).28 By promptly acknowledging the error and responding quickly to the problem, the service employee may even strengthen the firm’s relationship with the customer. Customer Satisfaction and Loyalty Four components of a firm’s offering and its customer-linking processes affect customer satisfaction: 1. The basic elements of the product or service that customers expect all competitors to provide; 25 William H. Davidow and Bro Uttal, “Service Companies: Focus or Falter,” Harvard Business Review 67 (July–August 1989): p. 84. 26 Valarie A. Zeithaml, “How Consumer Evaluation Processes Differ between Goods and Services,” in Marketing of Services, James H. Donnelly and William R. George, eds. (Chicago: American Marketing Association, 1981), pp. 200–204. 27 Ibid. 28 Christian Gronroos, “Relationship Marketing: Strategic and Tactical Implications,” Management Decision, 34 (no. 3, 1996): pp. 5–14. Chapter 10 Managing Services for Business Markets TABLE 10.3 269 THE DIMENSIONS OF SERVICE QUALITY Dimension Description Examples Reliability Responsiveness Delivering on promises Being willing to help Assurance Inspiring trust and confidence Treating customers as individuals Representing the service physically Promised delivery date met Prompt reply to customers’ requests Professional and knowledgeable staff Adapts to special needs of customer Distinctive materials: brochures, documents Empathy Tangibles SOURCE: Adapted from Valarie A. Zeithaml, Mary Jo Bitner, and Dwayne D. Gremler, Services Marketing: Integrating Customer Focus across the Firm, 5th ed. (Boston: McGraw-Hill Irwin, 2009), pp. 116–120. 2. Basic support services, such as technical assistance or training, that make the product or service more effective or easier to use; 3. A recovery process for quickly fixing product or service problems; 4. Extraordinary services that so excel in solving customers’ unique problems or in meeting their needs that they make the product or service seem customized.29 Leading service firms carefully measure and monitor customer satisfaction because it is linked to customer loyalty and, in turn, to long-term profitability.30 Xerox, for example, regularly surveys more than 400,000 customers regarding product and service satisfaction using a 5-point scale from 5 (high) to 1 (low). In analyzing the data, Xerox executives made a remarkable discovery: Very satisfied customers (a 5 rating) were far more loyal than satisfied customers. Very satisfied customers, in fact, were six times more likely to repurchase Xerox products than satisfied customers. Service Recovery Business marketers cannot always provide flawless service. However, the way the firm responds to a client’s service problems has a crucial bearing on customer retention and loyalty. Service recovery encompasses the procedures, policies, and processes a firm uses to resolve customer service problems promptly and effectively. For example, when IBM receives a customer complaint, a specialist who is an expert in the relevant product or service area is assigned as “resolution owner” of that complaint. On being assigned a customer complaint or problem, the IBM specialist must contact the customer within 48 hours (except in the case of severe problems, where the required 29 Thomas O. Jones and W. Earl Sasser Jr., “Why Satisfied Customers Defect,” Harvard Business Review 73 (November– December 1995): p. 90. 30 The Xerox illustration is based on James L. Heskett, Thomas O. Jones, Gary W. Loveman, W. Earl Sasser Jr., and Leonard A. Schlesinger, “Putting the Service-Profit Chain to Work,” Harvard Business Review 72 (March–April 1994): pp. 164–174. 270 Part IV Formulating Business Marketing Strategy response is made much faster). Larry Schiff, a marketing strategist at IBM, describes how the process works from there: They introduce themselves as owners of the customer’s problem and ask: What’s it going to take for you to be very satisfied with the resolution of this complaint? . . . Together with the customer, we negotiate an action plan and then execute that plan until the customer problem is resolved. The problem only gets closed when the customer says it is closed, and we measure this [that is, customer satisfaction with problem resolution] as well.31 Service providers who satisfactorily resolve service failures often see that their customer’s level of perceived service quality rises. One study in the ocean-freightshipping industry found that clients who expressed higher satisfaction with claims handling, complaint handling, and problem resolution have a higher level of overall satisfaction with the shipping line.32 Therefore, business marketers should develop thoughtful and highly responsive processes for dealing with service failures. Some studies have shown that customers who experienced a service failure and had it corrected to their satisfaction have greater loyalty to the supplier than those customers who did not experience a service failure! Zero Defections The quality of service provided to business customers has a major effect on customer “defections”—customers who do not come back. Service strategists point out that customer defections have a powerful effect on the bottom line.33 As a company’s relationship with a customer lengthens, profits rise—and generally rise considerably. For example, one service firm found that profit from a fourth-year customer is triple that from a first-year customer. Many additional benefits accrue to service companies that retain their customers: They can charge more, the cost of doing business is reduced, and the long-standing customer provides “free” advertising. The implications are clear: Service providers should carefully track customer defections and recognize that continuous improvement in service quality is not a cost but, say Frederick Reichheld and W. Earl Sasser, “an investment in a customer who generates more profit than the margin on a one-time sale.”34 Return on Quality A difficult decision for the business-services marketing manager is to determine how much to spend on improving service quality. Clearly, expenditures on quality have diminishing returns—at some point, additional expenditures do not increase profits. To make good decisions on the level of expenditures on quality, managers must justify 31 Larry Schiff, “How Customer Satisfaction Improvement Works to Fuel Business Recovery at IBM,” Journal of Organizational Excellence 20 (Spring 2001): p. 12. 32 Srinivas Durvasula, Steven Lysonski, and Subhash C. Mehta, “Business-to-Business Marketing: Service Recovery and Customer Satisfaction Issues with Ocean Shipping Lines,” European Journal of Marketing 34 (no. 3–4, 2000): p. 441. 33 Frederick F. Reichheld and W. Earl Sasser, “Zero Defections: Quality Comes to Services,” Harvard Business Review 68 (September–October 1990): p. 105; see also, Frederick F. Reichheld, Loyalty Rules! How Today’s Leaders Build Lasting Relationships (Boston: Harvard Business School Press, 2001). 34 Reichheld and Sasser, “Zero Defections,” p. 107. Chapter 10 Managing Services for Business Markets 271 quality efforts on a financial basis, knowing where to spend on quality improvement, how much to spend, and when to reduce or stop the expenditures. Roland Rust, Anthony Zahorik, and Timothy Keiningham have developed a technique for calculating the “return on investing in quality.”35 Under this approach, service quality benefits are successively linked to customer satisfaction, customer retention, market share, and, finally, to profitability. The relationship between expenditure level and customersatisfaction change is first measured by managerial judgment and then through market testing. When the relationship has been estimated, the return on quality can be measured statistically. The significant conclusion is that quality improvements should be treated as investments: They must pay off, and spending should not be wasted on efforts that do not produce a return. Marketing Mix for Business Service Firms Meeting the needs of service buyers effectively requires an integrated marketing strategy. First, target segments must be selected, and then a marketing mix must be tailored to the expectations of each segment. The business marketing manager must give special consideration to each of the key elements of the service marketing mix: development of service packages, pricing, promotion, and distribution. In terms of the overall approach that firms develop to interact with their customers, business-to-business service firms are more likely to emphasize relationship strategies as opposed to transactional strategies.36 Because the transactional mode involves an arm’s-length relationship, success in marketing business services hinges on the business marketer’s ability to develop close and long-lasting ties with customers— based on buyer-seller dependence. The emphasis in marketing business services is on managing the total buyer-seller interaction process. Segmentation As with any marketing situation, development of the marketing mix is contingent on the customer segment to be served. Every facet of the service, as well as the methods for promoting, pricing, and delivering it, hinges on the needs of a reasonably homogeneous group of customers. The process for segmenting business markets described in Chapter 5 applies in the services market. However, William Davidow and Bro Uttal suggest that customer service segments differ from usual market segments in significant ways.37 First, service segments are often narrower, often because many service customers expect services to be customized. Expectations may not be met if the service received is standardized and routine. Second, service segmentation focuses on what 35 Roland T. Rust, Anthony J. Zahorik, and Timothy L. Keiningham, “Return on Quality (ROQ): Making Service Quality Financially Accountable,” Journal of Marketing 59 (April 1995): pp. 58–70; see also Roland T. Rust, Katherine N. Lemon, and Valarie A. Zeithaml, “Return on Marketing: Using Customer Equity to Focus Marketing Strategy,” Journal of Marketing 68 (January 2004): pp. 109–127. 36 Nicole E. Coviello, Roderick J. Brodie, Peter J. Danaher, and Wesley J. Johnston, “How Firms Relate to Their Markets: An Empirical Examination of Contemporary Marketing Practices,” Journal of Marketing 66 (Summer 2002): p. 38. 37 Davidow and Uttal, “Service Companies,” p. 79. 272 Part IV Formulating Business Marketing Strategy the business buyers expect as opposed to what they need. Assessing buyer expectations plays a major role in selecting a target market and developing the appropriate service package. This assessment is critical because so many studies have shown large differences between the ways customers and suppliers define and rank different service activities.38 Because service-quality expectations play such an important role in determining ultimate satisfaction with a service, they can be used to segment business-to-business markets. One study in the mainframe software industry revealed significant differences between “software specialists” (software experts) and “applications developers” (users of software) in the same firm regarding their expectations of new software. The developers (users) had higher expectations about the quality of a supplier’s equipment, its employees’ responsiveness, and the amount of personal attention provided.39 The study concluded that different buying-center members may well have different perspectives and different expectations of service quality. The business marketer should carefully evaluate the possibility of using service-quality expectations as a guide for creating marketing strategy. Finally, segmenting service markets helps the firm adjust service capacity more effectively. Segmentation usually reveals that total demand is made up of numerous smaller, yet more predictable, demand patterns. A hotel can individually forecast and adjust its capacities to the demand patterns of convention visitors, business travelers, foreign tourists, or vacationers. Service Packages The service package can be thought of as the product dimension of service, including decisions about the essential concept of the service, the range of services provided, and the quality and level of service. In addition, the service package must consider some unique factors—the personnel who perform the service, the physical product that accompanies the service, and the process of providing the service.40 A useful way to conceptualize the service product is shown in Figure 10.3. Customer-Benefit Concept Services are purchased because of the benefits they offer, and a first step in either creating a service or evaluating an existing one is to define the customer-benefit concept—that is, evaluate the core benefit the customer derives from the service. Understanding the customer-benefit concept focuses the business marketer’s attention on those attributes—functional, effectual, and psychological—that must be not only offered but also tightly monitored from a quality-control standpoint. For example, a sales manager selecting a resort hotel for an annual sales meeting is purchasing a core benefit that could be stated as “a successful meeting.” The hotel marketer must then assess the full range of service attributes and components necessary to provide a successful meeting. Obviously, a wide variety of service elements come into play: (1) meeting-room size, layout, environment, 38 Ibid., p. 83. 39 Leyland Pitt, Michael H. Morris, and Pierre Oosthuizen, “Expectations of Service Quality as an Industrial Market Seg- mentation Variable,” Service Industries Journal 16 (January 1996): pp. 1–9; see also Ralph W. Jackson, Lester A. Neidell, and Dale A. Lunsford, “An Empirical Investigation of the Differences in Goods and Services as Perceived by Organizational Buyers,” Industrial Marketing Management 24 (March 1995): pp. 99–108. 40 Donald Cowell, The Marketing of Services (London: William Heinemann, 1984), p. 73. Chapter 10 Managing Services for Business Markets FIGURE 10.3 Level 1 273 CONCEPTUALIZING THE SERVICE PRODUCT Concerned with what benefits customers or clients seek Customer-Benefit Concept Translated into Level 2 Concerned with what general benefits the service organization will offer Service Concept Translated into Level 3 Service Offer Concerned with more detailed shaping of the service concept. Decisions on and clarification of: • service elements (tangible and intangible) • service forms (in what way, how) • service levels (quality and quantity) Translated into Level 4 Service-Delivery System Creation and delivery of the service product using guidelines built into the service offer. Concerned with people, processes, facilities, etc. SOURCE: Adapted from Donald Cowell, The Marketing of Services (London: William Heinemann, Ltd., 1984), p. 100. acoustics; (2) meals; (3) comfortable and quiet sleeping rooms; (4) audiovisual equipment; and (5) staff responsiveness. Service Concept Once the customer-benefit concept is understood, the next step is to articulate the service concept, which defines the general benefits the service company will provide through the bundle of goods and services it sells to the customer. The service concept translates the customer-benefit concept into the range of benefits the service marketer will provide. For a hotel, the service concept might specify the benefits that it will develop: flexibility, responsiveness, and courteousness in providing meeting rooms; a full range of audiovisual equipment; flexible meal schedules; message services; professional personnel; and climate-controlled meeting rooms. Service Offer Intimately linked with the service concept is the service offer, which spells out in more detail those services to be offered; when, where, and to whom they will be provided; and how they will be presented. The service elements that make up the total service package, including both tangibles and intangibles, must be determined. The service offer of the hotel includes a multitude of tangible elements (soundproof meeting rooms, projection equipment, video players, slide projectors, 274 Part IV Formulating Business Marketing Strategy flip charts, refreshments, heating and air-conditioning, meals) and intangible elements (attitude of meeting-room setup personnel, warmth of greetings from desk clerks and bellhops, response to unique requests, meeting-room ambiance). Generally, management finds it easier to manage the tangible (equipment and physical) elements of the service than to control the intangible elements. Service Delivery System The final dimension of the service product is the service delivery system—how the service is provided to the customer. The delivery system includes carefully conceived jobs for people; personnel with capabilities and attitudes necessary for successful performance; equipment, facilities, and layouts for effective customer work flow; and carefully developed procedures and processes aimed at a common set of objectives.41 Thus, the service delivery system should provide a carefully designed blueprint that describes how the service is rendered for the customer. For physical products, manufacturing and marketing are generally separate and distinct activities; for services, these two activities are often inseparable.42 The service performance and the delivery system both create the product and deliver it to customers. This feature of services underscores the important role of people, particularly service providers, in the marketing process. Technicians, repair personnel, and maintenance engineers are intimately involved in customer contact, and they decidedly influence the customer’s perception of service quality. The business service marketer must pay close attention to both people and physical evidence (tangible elements such as uniforms) when designing the service package. Lean Consumption James Womack and Daniel Jones suggest that the concept of “lean consumption” provides an effective way to think about how services are used.43 Lean consumption is focused on providing the full value that buyers desire from their goods and services, with the greatest efficiency and least trouble. When a business buys a computer system, for example, this is not a one-time transaction. The company has embarked on the arduous process of researching, obtaining, integrating, maintaining, upgrading, and finally, disposing of this product. For computer manufacturers (whether employees, managers, or entrepreneurs), developing lean consumption processes requires determining how to configure linked business activities, especially across firms, to meet customer needs without wasting their own—or the customer’s—time, effort, and resources. These favorable results are achieved by tightly integrating and streamlining the processes of provision and consumption. This approach has been pursued effectively by Fujitsu Services, a leading global provider of outsourced customer service. Companies that contract with Fujitsu to manage their in-house information technology help desks find that the number of calls their desks receive about a recurring problem—say, malfunctioning printers—often falls to near zero. What Fujitsu does is identify and fix the source of the problem—for example, replace the flawed printers with new ones. By seeking the root cause of the problem somewhere up the value stream (often involving multiple companies), Fujitsu has pioneered a way to eliminate problems and reduce costs.44 41 James L. Heskett, Managing in the Service Economy (Boston: Harvard Business School Press, 1986), p. 20. 42 Cowell, The Marketing of Services, p. 110. 43 James Womack and Daniel Jones, “Lean Consumption,” Harvard Business Review 83 (March 2005): p. 60. 44 Ibid., p. 61. Chapter 10 Managing Services for Business Markets 275 Service Personnel A first step in creating an effective service package is to ensure that all personnel know, understand, and accept the customer-benefit concept. As Donald Cowell states, “So important are people and their quality to organizations and . . . services that ‘internal marketing’ is considered to be an important management role to ensure that all staff are customer conscious.”45 In short, the attitudes, skills, knowledge, and behavior of service personnel have a critical effect on the customer’s level of satisfaction with the service. Pricing Business Services Although product and service pricing policies and strategies share many common threads, the unique characteristics of services create some special pricing problems and opportunities. Perishability and Managing Demand/Capacity The demand for services is rarely steady or predictable enough to avoid service perishability. An extremely difficult decision for the business service marketer is to determine the capacity (inventory) of the system: Should it meet peak demand, average demand, or somewhere in between? Pricing can be used to manage the timing of demand and align it with capacity. To manage demand, the marketer may offer off-peak pricing schemes and price incentives for service orders placed in advance. For example, resort hotels, crowded with pleasure travelers during school vacations and holidays, develop special packages for business groups during the off-season. Similarly, utilities may offer significant rate reductions for off-peak usage. It may also be possible, depending on demand elasticity and competition, to charge premium rates for services provided at peak demand periods. Interestingly, however, a recent study showed that many service firms do not reduce prices to increase business during slow periods.46 Service Bundling Many business services include a core service as well as various peripheral services. How should the services be priced—as an entity, as a service bundle, or individually? Bundling is the practice of marketing two or more services in a package for a special price.47 Bundling makes sense in the business service environment because most service businesses have a high ratio of fixed costs to variable costs and a high degree of cost sharing among their many related services. Hence, the marginal cost of providing additional services to the core service customer is generally low. A key decision for the service provider is whether to provide pure or mixed bundling.48 In pure bundling, the services are available only in bundled form—they cannot be purchased separately. In mixed bundling, the customer can purchase one or more services individually or purchase the bundle. For example, a public warehouse firm can provide its services—storage, product handling, and clerical activities—in a price-bundled form by charging a single rate (8 cents) for each case the warehouse receives from its manufacturer-client. Or the firm may market each service separately and provide a rate for each service individually (3 cents per case for storage, 4 cents 45 Cowell, The Marketing of Services, p. 110; see also, Francis X. Frei, “The Four Things a Service Business Must Get Right,” Harvard Business Review 86 (April 2008): pp. 70–80. 46 Zeithaml, Parasuraman, and Berry, “Problems and Strategies in Services Marketing,” p. 41. 47 Joseph P. Guiltinan, “The Price Bundling of Services: A Normative Framework,” Journal of Marketing 51 (April 1987): p. 74. 48 Ibid., p. 75. 276 Part IV Formulating Business Marketing Strategy per case for handling, and 1 cent per case for clerical). Additionally, a multitude of peripheral services can be quoted on an individual basis: physical inventory count, freight company selection and routing, merchandise return and repair, and so on. In this way, the customer can choose the services desired and pay for each separately. Creating a Service-Savvy Sales Force49 As companies move away from productrelated services into more elaborate customer solutions, a new set of challenges are presented to salespeople: Services require a long sales cycle and a complex sales process that often involves the participation of senior executives on both the buying and selling sides. To develop a focused strategy, the sales force at GE Healthcare includes both product and service specialists. The product salespeople are called “hunters,” centering their attention on securing customer orders for new equipment. Service salespeople are “farmers”; GE expects them to nurture and develop relationships, growing the service business over time. Isolate Service Profitability In many industries, firms often supply customers with myriad services such as next-day delivery, customized handling, and specialized labeling. However, not all companies track the real costs of the many services they offer and they have no concrete data on net profit margins. As a result, the high-volume customers who receive the lion’s share of these services may be far less profitable than companies think. As business marketers develop and price service offerings, they should give special attention to cost-to-serve particular customers and market segments50 (see Chapter 4). By incorporating cost-to-serve data into the calculation of gross margin, business marketing strategists are better equipped to price services, identify unprofitable customers, and take action to restore profitability. Services Promotion The promotional strategies for services follow many of the same prescriptions as those for products. However, the unique characteristics of business services pose special challenges for the business marketer. Developing Tangible Clues Service marketers must concentrate either on featuring the physical evidence elements of their service or on making the intangible elements more tangible. Physical evidence plays an important role in creating the atmosphere and environment in which a service is bought or performed, and it influences the customer’s perception of the service. Physical evidence is the tangible aspect of the service package that the business marketer can control. Attempts should be made to translate the image of a service’s intangible attributes into something more concrete. For business service marketers, uniforms, logos, written contracts and guarantees, building appearance, and color schemes are some of the many ways to make their services tangible. An equipment maintenance firm that provides free, written, quarterly inspections helps make its service more tangible. Xerox, IBM, and FedEx offer service guarantees for selected offerings. The credit card created by car rental companies is another example of an attempt to make a service more tangible. A key concern for the service marketer is to develop a well-defined strategy for managing physical evidence—to enhance and differentiate service evidence by creating tangible clues. 49 Werner Reinartz and Wolfgang Ulaga, “How to Sell More Services Profitably,” Harvard Business Review 86 (May 2008): pp. 90–96. 50 Remko Van Hoek and David Evans, “When Good Customers Are Bad,” Harvard Business Review 83 (September 2005): p. 9. Chapter 10 Managing Services for Business Markets 277 Services Distribution Distribution decisions in the service industry are focused on how to make the service package available and accessible to the user. Direct sale may be accomplished by the user going to the provider (for example, a manufacturer using a public warehouse for storing its product) or, more often, by the provider going to the buyer (for example, photocopier repair). Services can also be delivered over the Internet or provided by channel members. Delivering Services Through the Internet The Internet provides a powerful new channel for a host of services. For example, application service providers serve business market customers by allowing them to rent access to computer software and hardware, often providing the access over the Internet.51 To illustrate, for Dunn and Bradstreet, IBM pulls together credit information on 63 million companies, handles customer support and electronic credit-report distribution, and identifies good customer prospects with its analytic software.52 Channel Members Some manufacturers simply rely on their channel members to provide the services associated with the product. Because wholesalers and distributors are much closer to the customer, this arrangement can be a cost-effective way to deliver installation, repair, and maintenance services. IBM, although well known for its physical products, transformed itself into a services firm as a way to gain competitive advantage. While using a direct sales force to sell its services to large corporate customers, IBM found it difficult to cover the vast middle market in a cost-effective way. The middle market comprises customers with fewer than 2,000 employees or less than $500 million in revenue. IBM’s solution was to rely on business partners (channel members) to sell its services to these customers and to provide continuous support to partners and customers via the Internet. In this way, IBM expands its market coverage, responds to the service needs of customers, and increases the profitability and loyalty of its partners.53 Developing New Services54 In line with our discussion of the new-product-development process (see Chapter 9), research suggests that there are a small set of success factors that drive the outcome of new service ventures. Included here are ensuring an excellent fit to customer needs, involving expert front-line service managers in creating the new service and in helping customers appreciate its distinctive benefits, and implementing a formal and planned launch for the new service offering. Moreover, the study found, for new-to-the-world business services, the primary distinguishing feature impacting performance is the corporate culture—one that actively promotes entrepreneurship, encourages creativity, and includes the direct involvement of senior managers in the new-service-development process. 51 Jon G. Auerbach, “Playing the New Order: Stocks to Watch as Software Meets the Internet,” The Wall Street Journal, November 15, 1999, p. R28. 52 Steve Hamm, “Beyond Blue,” Business Week, April 18, 2005, pp. 68–76. 53 Craig Zarley, Joseph Kovar, and Edward Moltzen, “IBM Reaches,” Computer Reseller News 26 (February 2001): p. 14. 54 Ulrike de Brentani, “Innovative versus Incremental New Business Services: Different Keys for Achieving Success,” Journal of Product Innovation Management 18 (no. 3, 2001): pp. 169–187; see also, Adegoke Oke, “Innovation Types and Innovation Management Practices in Service Companies,” International Journal of Operations & Production Management 27 (no. 6, 2007): pp. 564–587. 278 Part IV Formulating Business Marketing Strategy Summary Customer satisfaction represents the culmination of a set of customer experiences with the business-to-business firm. A customer experience map provides a powerful platform for defining the most critical customer–company interactions, uncovering customer expectations, and spotting opportunities to create value and strengthen customer loyalty. Rather than selling individual products and services, leading-edge business-to-business firms focus on what customers really want—solutions. To design a solution, the business marketing manager begins by analyzing a customer problem and then identifies the products and services required to solve that problem. Because solutions can be more readily customized for individual customers, they provide more avenues for differentiation than products can offer. Business services are distinguished by their intangibility, linked production and consumption, lack of standardization, perishability, and use as opposed to ownership. Together, these characteristics have profound effects on how services should be marketed. Buyers of business services focus on five dimensions of service quality: reliability, responsiveness, assurance, empathy, and tangibles. Because of intangibility and lack of uniformity, service buyers have significant difficulty in comparing and selecting service vendors. Service providers must address this issue in developing their marketing mix. The marketing mix for business services centers on the traditional elements— service package, pricing, promotion, and distribution—as well as on service personnel, service delivery system, and physical evidence. The goal of the services marketing program is to create satisfied customers. A key first step in creating strategies is to define the customer-benefit concept and the related service concept and offer. Pricing concentrates on influencing demand and capacity as well as on the bundling of service elements. Promotion emphasizes developing employee communication, enhancing word-of-mouth promotion, providing tangible clues, and developing interpersonal skills of operating personnel. Distribution is accomplished through direct means, intermediaries, or the Internet. Firms, large and small, are using the Internet to forge closer relationships with customers and to deliver a vast array of new services. New service marketing can improve effectiveness by creating an organizational culture that fosters risk taking and innovation. Successful new services respond to carefully defined market needs, capitalize on the strengths and reputation of the firm, and issue from a well-planned new-service-development process. Discussion Questions 1. Local contractors who handle home remodeling and other building projects turn to Home Depot or Lowe’s for many products, tools, and materials. Describe how these retailers could adopt a solutions marketing focus to serve those customers. 2. When a company buys a high-end document processor from Xerox or Canon, it is buying a physical product with a bundle of associated services. Describe some of the services that might be associated with such a product. Develop a list of the elements or points of interaction that might be reflected in a customer experience map. How can buyers evaluate the quality or value of these services? Chapter 10 Managing Services for Business Markets 279 3. Explain why the growth opportunities for many firms, such as IBM or GE, are far greater in services than they are in products. 4. Leading service companies such as American Express and FedEx measure customer satisfaction on a quarterly basis across the global market. Discuss the relationship between customer satisfaction and loyalty. 5. Many firms have a recovery process in place for situations when their products or services fail to deliver what has been promised to the customer. Illustrate how such a process might work. 6. A new firm creates Web sites and electronic commerce strategies for small businesses. Describe the essential elements to be included in its service product. 7. What is the role of physical evidence in the marketing of a business service? 8. As a luxury resort hotel manager, what approaches might you utilize to manage business demand for hotel space? 9. Critique this statement: “A key dimension of success in services marketing, as opposed to products marketing, is that operating personnel in the service firm play a critical selling and marketing role.” 10. What steps can a manager take to enhance the chances of success for a new business service? Internet Exercise 1. Autodesk, Inc., a leading design software and digital content company, provides online collaborative services for the building industry that enables more effective management of all project information. Go to http://www.buzzsaw.com and describe the service solutions Autodesk provides for architects and engineers. CASE SafePlace Corporation55 In February 2002, a guest staying at the Hilton in Cherry Hill, New Jersey, died while attending a convention. Several other guests were sent to the hospital amid fears of an outbreak of Legionnaires’ disease or an anthrax attack. Later, it was determined that the guest had died from pneumonia and a blood infection unrelated to the hotel. The alarm surrounding this incident illustrates how important safety has become to a hotel’s business. In response to this need, John C. Fannin III, a fire protection and industrial security expert, formed and is the president of the SafePlace Corporation. The firm is an independent provider of safety accreditation of lodging, health care, educational, and commercial buildings and other occupancies where the safety of people is a concern. Like the “Good Housekeeping Seal of Approval,” SafePlace® Accreditation requirements are based on the security, fire protection, and health and life safety provisions of selected nationally recognized codes, standards, and best practices. The Hotel duPont in Wilmington, Delaware, was the first lodging facility in the United States to receive the SafePlace seal of approval. Such an accreditation process involves a rigorous inspection of the facility and identifies the best practices the hotel should employ, such as the use of key cards (as opposed to keys), self-closing doors, smoke detectors and sprinklers in the guest rooms, throw-bolt locks on the doors, excellent water quality, and safe work and food-handling practices among the hotel staff. The Hotel duPont, which paid a $45,000 fee for the inspection and consulting services, displays the SafePlace seal in the lobby and plans to feature the credential on all of the hotel’s marketing materials. Other early adopters of the SafePlace program are New Orleans’ Hotel Montcleone and the Sagamore in Bolton Landing, New York. Both report that their approvals have led to increased business. Tricia Hayes, director of marketing at The Sagamore said that SafePlace has brought meeting-planner attention to her facility and management comfort in adopting best risk-management practices. “Our accreditation has had a big impact on meeting professionals. Our sales managers use it as a sales tool.” Since launching its program, SafePlace is doing particularly well with independent hotels that, according to Fannin, are “quicker to respond to customer preferences than a chain would be.” In turn, Fannin feels that there is a huge opportunity in the education market, particularly with colleges and universities (for example, the accreditation of dormitories). Discussion Questions 1. Describe the core service concept and benefits that SafePlace provides to a hotel and its guests. How would you describe these benefits in the body of an ad? 2. What steps could John Fannin take to fuel the growth of SafePlace? 3. Assess the prospects for SafePlace in the education market and suggest a potential strategy the firm might follow to penetrate this market. 55 Maureen Milford, “Hotel Safety Rises to a New Standard,” The News Journal, May 13, 2002, p. i, accessed at http:// safeplace.com on September 27, 2002; , and “SafePlace Makes Hospitality Inroads,” Lodging Hospitality, February 2005, accessed at http://www.safeplace.com on October 15, 2005; and Ruth Hill, “What Hotel Guests Want Today: A Safe Haven in a Secure Property,” HSMAI Marketing Review, Fall 2005, accessed at http://www.safeplace.com on July 22, 2008. 280 CHAPTER 11 Managing Business Marketing Channels The channel of distribution is the marketing manager’s bridge to the market. Channel innovation represents a source of competitive advantage that separates market winners from market losers. The business marketer must ensure that the firm’s channel is properly aligned to the needs of important market segments. At the same time, the marketer must also satisfy the needs of channel members, whose support is crucial to the success of business marketing strategy. After reading this chapter, you will understand: 1. the alternative paths to business market customers. 2. the critical role of industrial distributors and manufacturers’ representatives in marketing channels. 3. the central components of channel design. 4. requirements for successful channel strategy. 281 282 Part IV Formulating Business Marketing Strategy Go to Market Strategy, an influential book by Lawrence G. Friedman, aptly describes the central focus of a channel strategy in the business market: The success of every go-to-market decision you make, indeed your ability to make smart go-to-market decisions at all, depends on how well you understand your customers. . . . You must build an accurate customer fact-base that clarifies who the customers are in your target market, what they buy, how they buy it, how they want to buy it, and what would motivate them to buy more of it from you.1 The channel component of business marketing strategy has two important and related dimensions. First, the channel structure must be designed to accomplish marketing objectives. However, selecting the best channel to accomplish objectives is challenging because (1) the alternatives are numerous, (2) marketing goals differ, and (3) business market segments are so various that separate channels must often be used concurrently. The ever-changing business environment requires managers periodically to reevaluate the channel structure. Stiff competition, new customer requirements, and the rapid growth of the Internet are among the forces that create new opportunities and signal the need for fresh channel strategies.2 Second, once the channel structure has been specified, the business marketer must manage the channel to achieve prescribed goals. To do so, the manager must develop procedures for selecting intermediaries, motivating them to achieve desired performance, resolving conflict among channel members, and evaluating performance. This chapter provides a structure for designing and administering the business marketing channel. The Business Marketing Channel The link between manufacturers and customers is the channel of distribution. The channel accomplishes all the tasks necessary to effect a sale and deliver products to the customer. These tasks include making contact with potential buyers, negotiating, contracting, transferring title, communicating, arranging financing, servicing the product, and providing local inventory, transportation, and storage. These tasks may be performed entirely by the manufacturer or entirely by intermediaries, or may be shared between them. The customer may even undertake some of these functions; for example, customers granted certain discounts might agree to accept larger inventories and the associated storage costs. Fundamentally, channel management centers on these questions: Which channel tasks will be performed by the firm, and which tasks, if any, will be performed by channel members? Figure 11.1 shows various ways to structure business marketing channels. Some channels are direct—the manufacturer must perform all the marketing functions needed to make and deliver products. The manufacturer’s direct sales force and online marketing channels are examples. Others are indirect; that is, some type of intermediary (such as a distributor or dealer) sells or handles the products. 1 Lawrence G. Friedman, Go to Market: Advanced Techniques and Tools for Selling More Products, to More Customers, More Profitably (Boston: Butterworth-Heinemann, 2002), p. 116. 2 Bert Rosenbloom, “Multi-Channel Strategy in Business-to-Business Markets,” Industrial Marketing Management 36 (January 2007): pp. 4–7. Chapter 11 Managing Business Marketing Channels FIGURE 11.1 283 B2B MARKETING CHANNELS Manufacturer Direct Channels Direct Sales Online Marketing Indirect Channels Telemarketing Manufacturers’ Representatives Industrial Distributors Customer Segments A basic issue in channel management, then, is how to structure the channel so that the tasks are performed optimally. One alternative is for the manufacturer to do it all. Direct Channels Direct distribution, common in business marketing, is a channel strategy that does not use intermediaries. The manufacturer’s own sales force deals directly with the customer, and the manufacturer has full responsibility for performing all the necessary channel tasks. Direct distribution is often required in business marketing because of the nature of the selling situation or the concentrated nature of industry demand. The direct sales approach is feasible when (1) the customers are large and well defined, (2) the customers insist on direct sales, (3) sales involve extensive negotiations with upper management, and (4) selling has to be controlled to ensure that the total product package is properly implemented and to guarantee a quick response to market conditions. A direct sales force is best used for the most complex sales opportunities: highly customized solutions, large customers, and complex products. Customized solutions and large customer accounts require professional account management, deep product knowledge, and a high degree of selling skill—all attributes a sales representative must possess. Also, when risk in a purchase decision is perceived as high and significant expertise is required in the sale, customers demand a high level of personal attention and relationship building from the direct sales force as a precondition for doing business. However, according to Lawrence Friedman and Timothy Furey, “in the broad middle market and small-customer market, where transactions are generally simpler, other channels can do a more cost-effective job—and can often reach more customers.”3 3 Lawrence G. Friedman and Timothy R. Furey, The Channel Advantage (Boston: Butterworth-Heinemann, 1999), p. 84. 284 Part IV Formulating Business Marketing Strategy INSIDE BUSINESS MARKETING IBM Uses the Internet to Collaborate with Channel Partners and Build Customer Loyalty The Internet provides a valuable way for business marketers to collaborate with distributors or other resellers, sharing resources and cooperating on electronic marketing initiatives. An excellent example of this channel outreach program is IBM TeamPlayers (http://www.ibm-teamplayers.com). This program uses the Web as a communications and information delivery tool to service the channel members (business partners) of IBM. IBM TeamPlayers offers channel members customized direct-mail campaigns using mail, fax, and e-mail to reach those customers. The Web site is also an outlet for providing help to channel partners in managing their customer databases, developing Web pages, executing telemarketing campaigns, and more, with IBM acting as a clearinghouse for other needed resources. The program strengthens IBM’s relationship with its channel partners. Moreover, the initiative allows IBM to identify and reach end users through the partners and helps strengthen customer loyalty to both IBM channel members and to IBM itself. SOURCE: Barry Silverstein, Business-to-Business Internet Marketing: Five Proven Strategies for Increasing Profits Through Internet Direct Marketing (Gulf Breeze, Fla.: MAXIMUM Press, 1999), p. 307. Many business marketing firms, such as Xerox, Cisco, and Dell, emphasize e-commerce strategies. Surprisingly, many firms use their Web sites only for promotional purposes and not yet as a sales channel. E-channels can be used by business marketing firms as (1) information platforms, (2) transaction platforms, and (3) platforms for managing customer relationships. The effect on the business increases as a firm moves from level one to level three. E-commerce strategies are fully explored in Chapter 12. Indirect Channels Indirect distribution uses at least one type of intermediary, if not more. Business marketing channels typically include fewer types of intermediaries than do consumergoods channels. Indirect distribution accounts for a large share of sales in the United States. The Gartner Group reports that 60 percent of the U.S. Gross Domestic Product (GDP) is sold through indirect channels.4 Manufacturers’ representatives and industrial distributors account for most of the transactions handled in this way. Indirect distribution is generally found where (1) markets are fragmented and widely dispersed, (2) low transaction amounts prevail, and (3) buyers typically purchase a number of items, often different brands, in one transaction.5 For example, IBM’s massive sales organization concentrates on large corporate, government, and institutional customers. Industrial distributors effectively and efficiently serve literally thousands of other IBM customers—small to medium-sized organizations. These channel partners assume a vital role in IBM’s strategy on a global scale. 4 The Gartner Group, “Partnerware Reports, ‘Top 10 Tips for Managing Indirect Sales Channels’,” http://www .businesswire.com, June 18, 2002. 5 E. Raymond Corey, Frank V. Cespedes, and V. Kasturi Rangan, Going to Market: Distribution Systems for Industrial Products (Boston: Harvard University Press, 1989), p. 26. Chapter 11 Managing Business Marketing Channels FIGURE 11.2 285 TYPICAL SALES CYCLE: TASKS PERFORMED THROUGHOUT THE SALES PROCESS Lead Generation Triggered by a sales call, a customer’s response to direct mail, or by a request for information through a Web site, an initial contact with a prospect is made. Lead Qualification Potential customer is screened: the prospect’s need for the product or service, buying interest, funding, and timeframe for making the purchase. Bid and Proposal Preparation of bid and proposal to meet customer’s requirements (a complex task for large technical projects). Negotiation and Sales Closure The negotiation of prices, terms, and conditions, followed by agreement on a binding contract. Fulfillment For standardized product or service, delivery of offering to customer. Configuration, customization, and installation for more complex sales. Customer Care and Support Post-sale problem resolution, customer guidance, and ongoing contact to insure customer retention, loyalty, and growth. SOURCE: Adapted from Lawrence G. Friedman, Go to Market Strategy: Advanced Techniques and Tools for Selling More Products, to More Customers, More Profitably (Boston: Butterworth-Heinemann, 2002), pp. 234–236. Integrated Multichannel Models6 Leading business marketing firms use multiple sales channels to serve customers in a particular market. The goal of a multichannel model is to coordinate the activities of many channels, such as field sales representatives, channel partners, call centers, and the Web, to enhance the total customer experience and profitability. Consider a typical sales cycle that includes the following tasks: lead generation, lead qualification, negotiation and sales closure, fulfillment, and customer care and support (Figure 11.2). In a multichannel system, different channels can perform different tasks within a single sales transaction with a customer. For example, business marketing firms might use a call center and direct mail to generate leads, field sales representatives to close sales, business partners (for example, industrial distributors) to provide fulfillment (that is, deliver or install product), and a Web site to provide postsale support. Managing Customer Contact Points Figure 11.3 shows a particular multichannel strategy that a number of leading firms like Oracle Corporation use to reach the vast middle market composed of many small and medium-sized businesses. First, the channels are arranged from top to bottom in terms of their relative cost of sales (that is, direct sales is the most expensive, whereas the Internet is the least). By shifting any selling tasks to lower-cost channels, the business marketer can boost profit margins and reach more customers, in more markets, more efficiently. 6 This section is based on Friedman, Go to Market, pp. 229–257. 286 Part IV Formulating Business Marketing Strategy MULTICHANNEL INTEGRATION MAP: SIMPLE EXAMPLE OF HIGH-COVERAGE PARTNERING MODEL FIGURE 11.3 Channel $$$ Sales task Lead generation Qualification Bid & proposal Negotiation/ sale closure Fulfillment Customer care & support Direct sales channel (field reps) Business partners Telechannels Direct mail $ Internet Sales Cycle SOURCE: Lawrence G. Friedman, Go to Market Strategy: Advanced Techniques and Tools for Selling More Products, to More Customers, More Profitably (Boston: Butterworth-Heinemann, 2002), p. 243. Copyright 2002. Reprinted with permission from Elsevier Science. Business Partner’s Key Role Returning to Figure 11.3, observe the central role of business partners across the stages of the sales cycle. Low-cost, direct-to-customer channels—like the Internet—are used to generate sales leads, which are then given to channel partners. These partners are then expected to complete the sales cycle but can secure assistance from Oracle’s sales representatives to provide guidance and support (when needed) in closing the sale. By emphasizing the partner channel for middle-market customers, Oracle can significantly increase market coverage and penetration while enjoying higher profit margins and lower selling costs. Moreover, this allows the sales force to concentrate on large enterprise customers. This provides just one example of how a firm can coordinate and configure sales cycle tasks across various sales channels to create an integrated strategy for a particular market. Any firm that serves a variety of markets requires distinctly different multichannel models to serve customers in those markets. To illustrate, a company might serve key corporate accounts through sales representatives and the middle market through channel partners, call centers, and the Internet. Customer Relationship Management (CRM) Systems Many business marketing firms pursue very complex market coverage strategies and use all of the alternative paths to the market we have discussed. For example, Hewlett-Packard sells directly through a field sales organization to large enterprises; through channel partners and resellers to the government, education, and the midsize business market; and through retail stores to the small business and home market. Notes Lawrence Friedman, a leading sales strategy consultant, “Add in its customer support channels, Web presence, Chapter 11 Managing Business Marketing Channels 287 and H-P has an army of channels that it deploys to provide sales, service, and support to its different market segments.”7 This multichannel mix features many points of contact that H-P must manage and coordinate to ensure a “singular” customer experience across channels. CRM systems provide a valuable tool for coordinating sales channel activities and managing crucial connections and handoffs between them (see Chapter 4). Friedman notes: Channel coordination used to be a difficult, messy problem involving the tracking and frequent loss of hand-written memos, voice mails, paper lists of sales leads, and dog-eared customer history files. CRM has ushered in a new era of IT-driven channel coordination, enabling electronic transmission of leads and customer histories from one channel to another, with no loss of information or sales information falling through the cracks.8 Participants in the Business Marketing Channel Channel members assume a central role in the marketing strategies of business-tobusiness firms, large and small. A channel management strategy begins with an understanding of the intermediaries that may be used. Primary attention is given to two: (1) industrial distributors and (2) manufacturers’ representatives. They handle a sizable share of business-to-business sales made through intermediaries. Distributors Industrial distributors are the most pervasive and important single force in distribution channels. Distributors in the United States number more than 10,000, with sales exceeding $50 billion. Distributors are heavily used for MRO (maintenance, repair, and operations) supplies, with many industrial buyers reporting that they buy as much as 75 percent of their MRO supplies from distributors. Generally, about 75 percent of all business marketers sell some products through distributors. What accounts for the unparalleled position of the distributor in the industrial market? What role do distributors play in the industrial distribution process? Distributors are generally small, independent businesses serving narrow geographic markets. Sales average almost $2 million, although some top $3 billion. Net profits are relatively low as a percentage of sales (4 percent); return on investment averages 11 percent. The typical order is small, and the distributors sell to a multitude of customers in many industries. The typical distributor is able to spread its costs over a sizable group of vendors—it stocks goods from between 200 and 300 manufacturers. A sales force of outside and inside salespersons generates orders. Outside salespersons make regular calls on customers and handle normal account servicing and technical assistance. Inside salespersons complement these efforts, processing orders and scheduling delivery; their primary duty is to take telephone orders. Most distributors operate from a single location, but some approach the “supermarket” status with as many as 130 branches. 7 Ibid., p. 254. 8 Ibid., p. 253. 288 Part IV Formulating Business Marketing Strategy TABLE 11.1 KEY DISTRIBUTION RESPONSIBILITIES Responsibility Activity Contact Reach all customers in a de?ned territory through an outside sales force that calls on customers or through an inside group that receives telephone orders Provide a local inventory and include all supporting activities: credit, just-in-time delivery, order processing, and advice Provide easy access to local repair facilities (unavailable from a distant manufacturer) Purchase material in bulk, then shape, form, or assemble to user requirements Product availability Repair Assembly and light manufacturing Compared with their smaller rivals, large distributors seem to have significant advantages. Small distributors are typically unable to achieve the operating economies larger firms enjoy.9 Large firms can automate much of their operations, enabling them to significantly reduce their sales and general administrative expenses, often to levels approaching 10 percent of sales. Distributor Responsibilities Table 11.1 shows industrial distributors’ primary responsibilities. The products they sell—cutting tools, abrasives, electronic components, ball bearings, handling equipment, pipe, maintenance equipment, and hundreds more—are generally those that buyers need quickly to avoid production disruptions. Thus, the critical elements of the distributor’s function are to have these products readily available and to serve as the manufacturer’s selling arm. Distributors are full-service intermediaries; that is, they take title to the products they sell, and they perform the full range of marketing functions. Some of the more important functions are providing credit, offering wide product assortments, delivering goods, offering technical advice, and meeting emergency requirements. Not only are distributors valuable to their manufacturer-suppliers but their customers generally view them favorably. Some purchasing agents view the distributor as an extension of their “buying arms” because they provide service, technical advice, and product application suggestions. A Service Focus To create more value for their customers, many large distributors have expanded their range of services. Value is delivered through various supply chain and inventory management services, including automatic replenishment, product assembly, in-plant stores, and design services.10 The most popular services involve helping customers design, construct, and, in some cases, operate a supply network. Other value-adding activities include partnerships in which the distributor’s field application engineers work at a customer’s site to help select components for new product designs. To reap the profits associated with these important services, many distributors now charge separate fees for each unique service. 9 Heidi Elliott, “Distributors, Make Way for the Little Guys,” Electronic Business Today 22 (September 1996): p. 19. 10 Jim Carbone, “Distributors See Slow Growth Ahead; Expect Electronics Distributors to Offer More Supply Chain and Inventory Services, but Be Prepared to Pay for Them,” Purchasing 130 (May 16, 2002): p. 27. Chapter 11 Managing Business Marketing Channels 289 Classification of Distributors To select the best distributor for a particular channel, the marketing manager must understand the diversity of distributor operations. Industrial distributors vary according to product lines and user markets. Firms may be ultraspecialized (for example, selling only to municipal water works), or they may carry a broad line of generalized industrial products. However, three primary distributor classifications are usually recognized. 1. General-line distributors cater to a broad array of industrial needs. They stock an extensive variety of products and could be likened to the supermarket in consumer-goods markets. 2. Specialists focus on one line or on a few related lines. Such a distributor may handle only power transmission equipment—belts, pulleys, and bearings. The most common specialty is fasteners, although specialization also occurs in cutting tools, power transmission equipment, pipes, valves, and fittings. There is a trend toward increased specialization as a result of increasing technical complexity of products and the need for higher levels of precision and quality control. 3. A combination house operates in two markets: industrial and consumer. Such a distributor might carry electric motors for industrial customers and hardware and automotive parts to be sold through retailers to final consumers. Choosing a Distributor The selection of a distributor depends on the manufacturer’s requirements and the needs of target customer segments. The general-line distributor offers the advantage of one-stop purchasing. If customers do not need a high level of service and technical expertise, the general-line distributor is a good choice. The specialist, on the other hand, provides the manufacturer with a high level of technical capability and a well-developed understanding of complex customer requirements. Specialists handle fasteners, for instance, because of the strict qualitycontrol standards that users impose. Manufacturers and their distributors are finding the Internet to be a major catalyst for stimulating collaboration. A recent poll asked distributors which business strategies would have the largest effect on them in the future, and the top two were collaboration with supply chain partners and new information technologies.11 E-collaboration includes sales and services, ordering and billing, technical training and engineering, Internet meetings, auctions, and exchanges. These results suggest that Internet collaboration is a critical strategic force in the business-to-business arena. The Distributor as a Valuable Partner The quality of a firm’s distributors is often the difference between a highly successful marketing strategy and an ineffective one. Customers prize good distributors, making it all the more necessary to strive continually to engage the best in any given market. Distributors often provide the only economically feasible way of covering the entire market. In summary, the industrial distributor is a full-service intermediary who takes title to the products sold; maintains inventories; provides credit, delivery, wide product assortment, and technical assistance; and may even do light assembly and manufacturing. Although the distributor is primarily responsible for contacting and supplying 11 Al Tuttle, “E-Collaboration: Build Trust and Success,” Industrial Distribution 92 ( June 1, 2002): p. 59. 290 Part IV Formulating Business Marketing Strategy present customers, industrial distributors also solicit new accounts and work to expand the market. They generally handle established products—typically used in manufacturing operations, repair, and maintenance—with a broad and large demand. Industrial distributors are a powerful force in business marketing channels, and all indications point to an expanded role for them. The manufacturer’s representative is an equally viable force in the business marketing channel. Manufacturers’ Representatives For many business marketers who need a strong selling job with a technically complex product, manufacturers’ representatives, or reps, are the only cost-effective answer. In fact, Erin Anderson and Bob Trinkle note that the one area untouched by the outsourcing boom is field selling in the business-to-business area. They contend that many companies could benefit by using outsourced sales professionals, namely manufacturers’ reps, to augment or even replace the field sales force.12 Reps are salespeople who work independently (or for a rep company), represent several companies in the same geographic area, and sell noncompeting but complementary products. The Rep’s Responsibilities A rep neither takes title to nor holds inventory of the products handled. (Some reps do, however, keep a limited inventory of repair and maintenance parts.) The rep’s forte is expert product knowledge coupled with a keen understanding of the markets and customer needs. Reps are usually limited to defined geographical areas; thus, a manufacturer seeking nationwide distribution usually works with several rep companies. Compared with a distributor channel, a rep generally gives the business marketer more control because the firm maintains title and possession of the goods. The Rep-Customer Relationship Reps are the manufacturers’ selling arm, making contact with customers, writing and following up on orders, and linking the manufacturer with the industrial end users. Although paid by the manufacturer, the rep is also important to customers. Often, the efforts of a rep during a customer emergency (for example, an equipment failure) mean the difference between continuing or stopping production. Most reps are thoroughly experienced in the industries they serve—they can offer technical advice while enhancing the customer’s leverage with suppliers in securing parts, repair, and delivery. The rep also provides customers with a continuing flow of information on innovations and trends in equipment, as well as on the industry as a whole. Commission Basis Reps are paid a commission on sales; the commission varies by industry and by the nature of the selling job. Commissions typically range from a low of 2 percent to a high of 18 percent for selected products. The average commission rate is 5.3 percent.13 Percentage commission compensation is attractive to manufacturers because they have few fixed sales costs. Reps are paid only when they generate orders, and commissions can be adjusted based on industry conditions. Because reps are paid on commission, they are motivated to generate high levels of sales—another fact the manufacturer appreciates. 12 Erin A. Anderson and Bob Trinkle, Outsourcing the Sales Function: The Real Cost of Field Sales (Mason, Ohio: Thomson Higher Education, 2005); see also, Daniel H. McQuiston, “A Conceptual Model for Building and Maintaining Relationships between Manufacturers’ Reps and Their Principals,” Industrial Marketing Management 30 (February 2001): pp. 165–181. 13 Ibid., p. 22. Chapter 11 Managing Business Marketing Channels 291 B2B TOP PERFORMERS Why Intel Uses Reps Intel has a strong corporate brand, an experienced corporate sales force, and long-standing relationships with broad-line distributors like Arrow Electronics. Intel also uses manufacturers’ representatives. Why? After purchasing a business unit from Digital Equipment Corporation in 1998, Intel realized that several product lines from the acquired unit provided promising market potential, particularly in networking and communications. Specifically, the product lines could spur profitable growth in embedded applications market segments, such as medical equipment and point-of-sale terminals, where the proper application function is based on microprocessors and network connections. At Intel, however, marketing managers argued that the go-to-market strategy that has proved so successful in the PC market would not be suitable for original equipment manufacturers (OEMs) in these sectors. George Langer, Intel’s worldwide representative program manager, explains: There was no sales organization, few customer relationships, and more than a few OEMs who questioned Intel’s renewed interest in the embedded segments. Intel did not have existing capability to get these product lines in front of appropriate customers. The customer base was large and diverse. (This was not the PC OEM customer base where Intel had nurtured strong relationships over time.) And, finally, the value of the Intel brand was not clearly associated with communications, embedded, and networking market segments. Intel turned to outsourced selling [that is, manufacturers’ reps]. SOURCE: Erin Anderson and Bob Trinkle, Outsourcing the Sales Function: The Real Cost of Field Sales (Mason, Ohio: Thomson Higher Education, 2005), pp. 74–75. Experience Reps possess sophisticated product knowledge and typically have extensive experience in the markets they serve. Most reps develop their field experience while working as salespersons for manufacturers. They are motivated to become reps by the desire to be independent and to reap the substantial monetary rewards possible on commission. When Reps Are Used • Large and Small Firms: Small and medium-sized firms generally have the greatest need for a rep, although many large firms—for example, Dow Chemical, Motorola, and Intel—use them. The reason is primarily economic: Smaller firms cannot justify the expense of maintaining their own sales forces. The rep provides an efficient way to obtain total market coverage, with costs incurred only as sales are made. The quality of the selling job is often very good as a result of the rep’s prior experience and market knowledge. • Limited Market Potential: The rep also plays a vital role when the manufacturer’s market potential is limited. A manufacturer may use a direct sales force in heavily concentrated business markets, where the demand is sufficient to support the expense, and use reps to cover less-dense markets. Because the rep carries several lines, expenses can be allocated over a much larger sales volume. • Servicing Distributors: Reps may also be employed by a firm that markets through distributors. When a manufacturer sells through hundreds of distributors across the United States, reps may sell to and service those distributors. 292 Part IV Formulating Business Marketing Strategy • Reducing Overhead Costs: Sometimes the commission rate paid to reps exceeds the cost of a direct sales force, yet the supplier continues to use reps. This policy is not as irrational as it appears. Assume, for example, that costs for a direct sales force approximate 8 percent of sales and that a rep’s commission rate is 11 percent. Using reps in this case is often justified because of the hidden costs of a sales force. First, the manufacturer does not provide fringe benefits or a fixed salary to reps. Second, the costs of training a rep are usually limited to those required to provide product information. Thus, using reps eliminates significant overhead costs. Multiple Paths to Market A wide array of factors influences the choice of intermediaries, with the tasks they perform being of prime importance. Different Market Segments The primary reason for using more than one type of intermediary for the same product is that different market segments require different channel structures. Some firms use three distinct approaches. Large accounts are called on by the firm’s own sales force, distributors handle small repeat orders, and manufacturers’ reps develop the medium-sized firm market. How Customers Buy Like size of accounts, differences in purchase behavior may also dictate using more than one type of intermediary. If a firm produces a wide line of industrial products, some may require high-caliber selling to numerous buying influences in a single buyer’s firm. When this occurs, the firm’s own sales force would focus on the more complex buying situations, whereas the distributors would sell standardized products from local stocks. Channel Design Channel design is the dynamic process of developing new channels where none existed and modifying existing channels. The business marketer usually deals with modification of existing channels, although new products and customer segments may require entirely new channels. Regardless of whether the manager is dealing with a new channel or modifying an existing one, channel design is an active rather than a passive task. Effective distribution channels do not simply evolve; they are developed by management, which takes action on the basis of a well-conceived plan that reflects overall marketing goals. Business firms formulate their marketing strategies to appeal to selected market segments, to earn targeted levels of profits, to maintain or increase sales and market share growth rates, and to achieve all this within specified resource constraints. Each element of the marketing strategy has a specific purpose. Channel design is best conceptualized as a series of stages that the business marketing manager must complete to be sure that all important channel dimensions have been evaluated (Figure 11.4). The result of the process is to specify the structure that provides the highest probability of achieving the firm’s objectives.14 Note that the process focuses on channel structure and not on channel participants. Channel structure refers to the underlying framework: the number of channel levels, the number and types of intermediaries, and the linkages among channel members. Selection of individual intermediaries is indeed important—it is examined later in the chapter. 14 The discussion that follows is based on V. Kasturi Rangan, Transforming Your Go-To-Market Strategy: The Three Disciplines of Channel Management (Boston: Harvard Business Press, 2006), pp. 73–88. Chapter 11 Managing Business Marketing Channels FIGURE 11.4 293 THE CHANNEL DESIGN PROCESS Step 1 End-User Focus: Define Customer Segments Step 2 Identify and Prioritize Customers’ Channel Requirements by Segment Step 3 Assess the Firm’s Capabilities to Meet Customers’ Requirements Step 4 Benchmark Channel Offerings of Key Competitors Step 5 Create Channel Solutions to Customers’ Latent Needs Step 6 Evaluate and Select Channel Options SOURCE: Adapted from V. Kasturi Rangan, Transforming Your Go-To-Market Strategy: The Three Disciplines of Channel Management (Boston: Harvard Business Press, 2006), pp. 73–94. Step 1: Define Customer Segments The primary goal of the distribution channel is to satisfy end-user needs, so the channel design process should begin there. Step 1 is about defining target market segments (see Chapter 5) and isolating the customer buying and usage behavior in each segment (what they buy, how they buy, and how they put their purchases to use). Some business marketers err by considering their channel partners as “customers and rarely looking beyond them.” To inform the channel design process, however, the marketing strategist should center on the importance of the product from the customer’s perspective. V. Kasturi Rangan observes: Producers of agricultural channels, for example, should target farmers and not dealers. Producers of engineering plastics (pellets) for automobile bumpers, on the other hand, should focus on the auto manufacturer and not the consumer, because that is where the product has value in the eyes of the end user. . . . Other features of the automobile (not bumpers) are more salient [in the choice decision at the consumer level].15 Step 2: Customers’ Channel Needs by Segment Identifying and prioritizing the channel function requirements for customers in each market segment is next. This information should be elicited directly from a sample of present or potential customers from each segment. Table 11.2 provides a representative list of channel functions that may be more or less important to customers in a particular segment. For example, large customers for information-technology products might rank product customization, product quality assurance, and after-sales service as their top three needs. Whereas small customers may prioritize product information, assortment, and availability as their most important needs. The business marketing manager should also probe customers on other issues that might provide strategy 15 Ibid., p. 76. 294 Part IV Formulating Business Marketing Strategy TABLE 11.2 CHANNEL FUNCTIONS ALIGNED wITH CUSTOMER NEEDS Channel Function Customer Needs 1. Product Information Customers seek more information for new and/or technically complex products and those that are characterized by a rapidly changing market environment. Some products must be technically modified or need to be adapted to meet the customer’s unique requirements. Because of its importance to the customer’s operations, product integrity and reliability might be given special emphasis by customers. For products that have a high unit value or those that are used extensively, the purchase represents a sizable dollar outlay and a significant financial decision for the customer. A customer may require a broad range of products, including complementary items, and assign special value to one-stop shopping. Some customer environments require the channel to manage demand uncertainty and support a high level of product availability. Customers require a range of services from installation and repair to maintenance and warranty. A customer organization may require special transportation and storage services to support its operations and strategy. 2. Product Customization 3. Product Quality Assurance 4. Lot Size 5. Assortment 6. Availability 7. After-Sales Services 8. Logistics SOURCE: Adapted from V. Kasturi Rangan, Melvyn A. J. Menezes, and E. B. Maier, “Channel Selection for New Industrial Products: A Framework, Method, and Application,” Journal of Marketing 56 ( July 1992): pp. 72–74. insights. For instance, how sensitive are customers to a two-hour versus six-hour service response time, or how much value do they perceive in a three-year versus one-year warranty? Step 3: Assess the Firm’s Channel Capabilities Once customer requirements have been isolated and prioritized, an assessment is made of the strengths and weaknesses of the firm’s channel. The central focus is on identifying the gaps between what customers in a segment desire and what the channel is now providing. Customers base their choice of a channel not on a single element, but on a complete bundle of benefits (that is, channel functions). To that end, the business-to-business firm should identify particular channel functions, like aftersales support or availability, where action could be taken to enhance the customer value proposition. Step 4: Benchmark to Competitors What go-to-market strategies are key competitors using? In designing a channel, cost considerations prevent the business marketer from closing all the gaps on channel capabilities that may appear. However, a clear direction for strategy is revealed by understanding the channel offerings of competitors. For example, an aggressive Chapter 11 Managing Business Marketing Channels 295 competitor that goes to market with its own team of account managers and dedicated service specialists might demonstrate special strength in serving large corporate customers. However, countless opportunities exist for smaller rivals to counter this strategy by developing special channel offerings tailored to small and medium-sized customers (for example, Intuit’s success in retaining its market leadership position in small-business accounting software despite the aggressive challenge from Microsoft). Step 5: Create Channel Solutions for Customers’ Latent Needs Sometimes, a review of competitor offerings can alert the marketer to opportunities for new offerings that may have special appeal to customers. “At other times, customers’ needs may be latent and unarticulated, and it is the channel steward’s responsibility to tap into and surface those requirements.”16 Based on such an assessment, a provider of information-technology equipment created an entirely new channel option for the small and medium-sized customer segment. Rather than selling equipment, this new channel takes responsibility for installing, upgrading, and maintaining the equipment at the customers’ locations for an ongoing service fee. Step 6: Evaluate and Select Channel Options Channel decisions must ultimately consider the cost-benefit trade-offs and the estimated profitability that each of the viable channel options present.17 Some of the channel gaps that are uncovered in this assessment can be closed by the independent actions and investments of the business-to-business firm (for example, adding to the service support staff or the sales force). For the most part, however, the greatest progress will come from the channel partners (for example, distributors or reps) working together and discussing how channel capabilities can be aligned to customer needs. “The idea is to enhance the value delivered to customers through collaborative action among channel partners. If the partners can agree on how to pull it off and, indeed, accomplish their redefined tasks,”18 they will squarely respond to customer needs and advance the performance of the channel. One important implication of the framework is that the design of the channel must change as customer and competitor behavior changes. Rather than a static structure, channel management is an ongoing process involving continuous adjustments and evolution. Crucial Points in Channel Transformation Marketing channels are often thought of as a series of product and information flows that originate with the business-to-business firm. In his rich and compelling perspective of the channel design process, V. Kasturi Rangan turns this notion on its head (see Figure 11.5): The starting point is the customer, and the customer’s demand-chain requirements. The channel is constructed to meet this core need. Roles, responsibilities, and rewards are allocated as a consequence of this need, and not the other way around.19 16 Ibid., p. 83. 17 Arun Sharma and Anuj Mehrotra, “Choosing an Optimal Mix in Multichannel Environments,” Industrial Marketing Management 36 (January 2007): pp. 21–28. 18 Rangan, Transforming Your Go-to-Market Strategy, p. 88. 19 Ibid., p. 91. 296 Part IV Formulating Business Marketing Strategy FIGURE 11.5 CUSTOMERS DRIVE THE CHANNEL DESIGN PROCESS Customer Service Installation Assortment Channel Partner Size Financing Guarantees Customization Information Channel Partner Supplier SOURCE: V. Kasturi Rangan, Transforming Your Go-To-Market Strategy: The Three Disciplines of Channel Management (Boston: Harvard Business Press, 2006), p. 91. Channel Administration Once a particular business-to-business channel structure is chosen, channel participants must be selected, and arrangements must be made to ensure that all obligations are assigned. Next, channel members must be motivated to perform the tasks necessary to achieve channel objectives. Third, conflict within the channel must be properly controlled. Finally, performance must be controlled and evaluated. Selection of Channel Members Why is the selection of channel members (specific companies, rather than type, which is specified in the design process) part of channel management rather than an aspect of channel design? The primary reason is that intermediary selection is an ongoing process—some intermediaries choose to leave the channel, and the supplier terminates others. Thus, selection of intermediaries is more or less continuous. Performance of individual channel members must be evaluated continually. The manufacturer should be prepared to move quickly, replacing poor performers with potentially better ones. Including the selection process in ongoing channel management puts the process in its proper perspective. Securing Good Intermediaries The marketer can identify prospective channel members through discussions with company salespeople and existing or potential customers, or through trade sources, such as Industrial Distribution magazine or the Verified Directory of Manufacturers’ Representatives. Once the list of potential intermediaries is reduced to a few names, the manufacturer uses the selection criteria to evaluate them. For example, the McGraw-Edison Company uses an intensive checklist to compare prospective channel members; important criteria are market coverage, product lines, personnel, growth, and financial standing. The formation of the channel is not at all a one-way street. The manufacturer must now persuade the intermediaries to become part of the channel system. Some distributors Chapter 11 Managing Business Marketing Channels 297 evaluate potential suppliers just as rigorously as the manufacturers rate them— using many of the same considerations. Manufacturers must often demonstrate the sales and profit potential of their product and be willing to grant the intermediaries some territorial exclusivity. Special efforts are required to convince the very best rep in a market to represent a particular manufacturer’s product. Those efforts must demonstrate that the manufacturer will treat the rep organization as a partner and support it. Motivating Channel Members Distributors and reps are independent and profit oriented. They are oriented toward their customers and toward whatever means are necessary to satisfy customer needs for industrial products and services. Their perceptions and outlook may differ substantially from those of the manufacturers they represent. As a consequence, marketing strategies can fail when managers do not tailor their programs to the capabilities and orientations of their intermediaries. To manage the business marketing channel effectively, the marketer must understand the intermediaries’ perspective and devise ways to motivate them to perform in a way that enhances the manufacturer’s long-term success. The manufacturer must continually seek support from intermediaries, and the quality of that support depends on the motivational techniques used. A Partnership Channel member motivation begins with the understanding that the channel relationship is a partnership. Manufacturers and intermediaries are in business together; whatever expertise and assistance the manufacturer can provide to the intermediaries improves total channel effectiveness. One study of channel relationships suggested that manufacturers may be able to increase the level of resources directed to their products by developing a trusting relationship with their reps; by improving communication through recognition programs, product training, and consultation with the reps; and by informing the reps of plans, explicitly detailing objectives, and providing positive feedback.20 Another study of distributor-manufacturer working partnerships recommended similar approaches. It also suggested that manufacturers and their distributors engage in joint annual planning that focuses on specifying the cooperative efforts each firm requires of its partner to reach its objectives and that periodically reviews progress toward objectives.21 The net result is trust and satisfaction with the partnership as the relationship leads to meeting performance goals. Dealer Advisory Councils One way to enhance the performance of all channel members is to facilitate the sharing of information among them. Distributors or reps may be brought together periodically with the manufacturer’s management to review distribution policies, provide advice on marketing strategy, and supply industry intelligence.22 Intermediaries can voice their opinions on policy matters and are brought directly into the decision-making process. Dayco Corporation uses a dealer council to 20 Erin Anderson, Leonard M. Lodish, and Barton A. Weitz, “Resource Allocation in Conventional Channels,” Journal of Marketing Research 24 (February 1987): p. 95; see also McQuiston, “A Conceptual Model for Building and Maintaining Relationships between Manufacturers’ Reps and Their Principals,” pp. 165–181. 21 James C. Anderson and James A. Narus, “A Model of Distribution Firm and Manufacturing Firm Working Partner- ships,” Journal of Marketing 54 (January 1990): p. 56. 22 Doug Harper, “Councils Launch Sales Ammo,” Industrial Distribution 80 (September 1990): pp. 27–30. 298 Part IV Formulating Business Marketing Strategy keep abreast of distributors’ changing needs.23 One month after their meeting, council members receive a written report of suggestions they made and of the programs to be implemented as a result. Generally, Dayco enacts 75 percent of distributor proposals. For dealer councils to be effective, the input of channel members must have a meaningful effect on channel policy decisions. Margins and Commission In the final analysis, the primary motivating device is compensation. The surest way to lose intermediary support is compensation policies that do not meet industry and competitive standards. Reps or distributors who feel cheated on commissions or margins shift their attention to products generating a higher profit. The manufacturer must pay the prevailing compensation rates in the industry and must adjust the rates as conditions change. Intermediaries’ compensation should reflect the marketing tasks they perform. If the manufacturer seeks special attention for a new industrial product, most reps require higher commissions. As noted earlier in the chapter, many industrial distributors charge separate fees for the value-added services they provide. For this approach to work effectively, it is critical that the client understands the value it is receiving for the extra charges. Building Trust The very nature of a distribution channel—with each member dependent on another for success—can invite conflict. Conflict can be controlled in various ways, including channelwide committees, joint goal setting, and cooperative programs involving a number of marketing strategy elements. To compete, business marketers need to be effective at cooperating within a network of organizations—the channel. For example, an IBM executive who led the team that developed the first IBM PC in 1981 also drove the decision to sell it through dealers and later through the channel. Soon after the introduction of the PC, an executive with American Express Travel Related Services approached the IBM executive with an idea to sell the PCs directly to American Express card members. The IBM executive refused—he wanted the channel to get the sale. As a result, IBM secured the commitment and trust of its channel partners, setting the stage for many other strategy initiatives.24 Successful cooperation results from relationships in which the parties have a strong sense of communication and trust. Robert M. Morgan and Shelby D. Hunt suggest that relationship commitment and trust develop when (1) firms offer benefits and resources that are superior to what other partners could offer; (2) firms align themselves with other firms that have similar corporate values; (3) firms share valuable information on expectations, markets, and performance; and (4) firms avoid taking advantage of their partners.25 By following these prescriptions, business marketers and their channel networks can enjoy sustainable competitive advantages over their rivals and their networks. 23 James A. Narus and James C. Anderson, “Turn Your Distributors into Partners,” Harvard Business Review 64 (March–April 1986): p. 68. 24 Jeff O’Heir, “The Advocates: They Raised Their Voices to Legitimize the Channel,” Computer Reseller News, June 17, 2002, p. 51. 25 Robert M. Morgan and Shelby D. Hunt, “The Commitment-Trust Theory of Relationship Marketing,” Journal of Marketing 58 (July 1994): pp. 20–38. Chapter 11 Managing Business Marketing Channels 299 Summary Channel strategy is an exciting and challenging aspect of business marketing. The challenge derives from the number of alternatives available to the manufacturer in distributing business products. The excitement results from the ever-changing nature of markets, user needs, and competitors. Channel strategy involves two primary management tasks: designing the overall structure and managing the operation of the channel. Channel design includes evaluating distribution goals, activities, and potential intermediaries. Channel structure includes the number, types, and levels of intermediaries to be used. A central challenge is determining how to create a strategy that effectively blends e-commerce with traditional channels. Business marketing firms use multiple sales channels to serve customers in a particular market segment: company salespersons, channel partners, call centers, direct mail, and the Internet. The goal of a multichannel strategy is to coordinate activities across those channels to enhance the customer’s experience while advancing the firm’s performance. The primary participants in business marketing channels are distributors and reps. Distributors provide the full range of marketing services for their suppliers, although customer contact and product availability are their most essential functions. Manufacturers’ representatives specialize in selling, providing their suppliers with quality representation and with extensive product and market knowledge. The rep is not involved with physical distribution, leaving that burden to the manufacturers. The central objective of channel management is to enhance the value delivered to customers through the carefully orchestrated activities of channel partners. The channel design process hinges on deep knowledge of customer needs, and the channel structure must be adjusted as customer or competitor behavior changes. Selection and motivation of channel partners are two management tasks vital to channel success. The business marketing manager may need to apply interorganizational management techniques to resolve channel conflict. Conflict can be controlled through a variety of means, including channelwide committees, joint goal setting, and cooperative programs that demonstrate trust and commitment. Discussion Questions 1. Describe the specific tasks in the typical sales cycle and discuss how different channels (for example, business partners versus the Internet) can perform different tasks within a single sales transaction. 2. Using a multichannel integration map (see Figure 11.3), illustrate how a firm might cover small and medium-sized businesses versus large corporate customers. 3. Explain how a direct distribution channel may be the lowest-cost alternative for one business marketer and the highest-cost alternative for another in the same industry. 4. Describe specific product, market, and competitive conditions that lend themselves to (a) a direct channel of distribution and (b) an indirect channel of distribution. 300 Part IV Formulating Business Marketing Strategy 5. Compare and contrast the functions performed by industrial distributors and manufacturers’ representatives. 6. What product/market factors lend themselves to the use of manufacturers’ representatives? 7. Describe why it might be necessary for a business-to-business firm to serve some customers through reps, some through distributors, others exclusively online, and still others through a direct sales force. 8. Explain how a change in segmentation policy (that is, entering new markets) may trigger the need for drastic changes in the industrial channel of distribution. 9. Both business marketers and distributors are interested in achieving profit goals. Why, then, are manufacturer-distributor relationships characterized by conflict? What steps can the marketer take to reduce conflict and thus improve channel performance? 10. For many years, critics have charged that intermediaries contribute strongly to the rising prices of goods in the American economy. Would business marketers improve the level of efficiency and effectiveness in the channel by reducing as far as possible the number of intermediate links in the channel? Support your position. Internet Exercise 1. Sysco Corporation is a large distributor of food and food-related products to the food-service industry. The company provides its products and services to approximately 415,000 customers, including restaurants, health-care and educational facilities, lodging establishments, and other food-service customers. Although Cisco is most visible in the business press, Sysco generates over $23 billion in sales annually and has more than 45,000 employees. Go to http://www.sysco.com and identify some of the services Sysco provides. CASE SunPower’s Go-to-Market Strategy26 SunPower Corporation, a Silicon Valley–based manufacturer of solar cells and solar panels, is emerging as a potential leader in the rapidly growing, but still immature, solar industry. The firm is the leader in cell conversion efficiency, which means that its solar cells generate more electricity at a given size than its rivals. So, when space constraints and aesthetics are important considerations, this attribute makes SunPower an ideal choice for business as well as home installations. To boost energy savings, the company has also developed its own tracking systems that allow its solar panels to follow the sun throughout the day. While costing only 5 percent more to install, this proprietary feature allows for 30 percent more energy generation than traditional solar systems. SunPower serves all sectors of the business market and its customer list includes Johnson & Johnson, FedEx, Toyota, the U.S. Postal Service, and Microsoft. The company has signed agreements with Macy’s, Target, and WalMart to install solar systems at all of their California locations, and this may develop into a much larger opportunity, spreading to those customers’ operations across the country. In serving large corporate customers, like Macy’s, SunPower uses a direct channel that controls the complete value chain from the manufacturing of the solar panels to the installation of the system. However, the firm also sees a huge opportunity in selling its solar systems to small and medium-sized businesses (SMBs). For smaller commercial installations (less than 500 kW of peak power), SunPower is developing an indirect channel—a network of commercial dealers that will serve those SMB customers. For customers in this market segment, SunPower emphasizes these benefits: • lowering the monthly electric bills for your business; • installing fewer panels that provide more power, thereby reducing your costs; • taking advantage of government incentives for solar installations; • supporting the environment and your community. Discussion Questions 1. Channel design begins with an assessment of customer needs. What benefits or special services should a SunPower commercial dealer provide in order to meet the unique requirements of an SMB customer? 26 Stephen Simko, “Analyst Research: SunPower Corporation,” July 22, 2008, Morningstar, Inc., accessed at http://www .morningstar.com on July 26, 2008. 301 302 Part IV Formulating Business Marketing Strategy 2. Describe the process that SunPower might follow to (a) evaluate potential dealers and (b) select those that will represent them in a particular city or geographical area. 3. To effectively implement channel strategy, what programs or strategies might SunPower take to better prepare and equip commercial dealers to serve SMB customers? CHAPTER 12 E-Commerce Strategies for Business Markets Leading-edge firms are using the Internet to transform the way they do business. The Internet provides a powerful platform for conveying information, conducting transactions, delivering innovative services, and building close customer relationships. After reading this chapter, you will understand: 1. the nature of e-commerce in business markets. 2. the role of e-commerce in a firm’s marketing strategy. 3. the key issues involved in designing an e-commerce strategy. 303 304 Part IV Formulating Business Marketing Strategy Before the Internet, customers had to call Dow Chemical and request a specification sheet for the products they were considering. The information would arrive a few days later by mail. After choosing a product, the customer could then place an order by calling Dow (during business hours, of course). Now, though, such information is available anytime at Dow.com. In turn, a host of more personalized services are available through MyAccount@Dow, which provides information tailored to the customer’s requirements.1 For example, MyAccount@Dow offers secure internal monitoring of a customer’s chemical tank levels. When tanks reach a predetermined level, reordering can be automatically triggered. Similarly, Dell’s large-enterprise customers can use its online resources to manage the inventory of personal computers across the organization, properly configure and upgrade them for different departments, and control the purchase order process in line with the customer’s own budget restrictions.2 Dow Chemical and Dell represent just two of thousands of business marketers who have integrated the Internet and electronic commerce into their corporate strategies. E-commerce not only speeds up and automates a company’s internal processes but, just as importantly, spreads the efficiency gains to the business systems of its suppliers and customers. For example, Dell customers can shop online using their own Enterprise Resource Planning (ERP) procurement application, route the electronic requisition through the firm’s standard ERP workflow where it can be approved electronically, creating a purchase order that is transmitted instantly to Dell. This order then flows directly into Dell’s manufacturing system where the equipment is built immediately and shipped, providing the customer with a timely and efficient solution.3 In other applications, e-commerce seamlessly moves data and information over open and closed networks, bringing together previously separate groups inside the organization and throughout the supply chain. By integrating suppliers and customers in this way, the Internet and e-commerce provide powerful tools that are ideally suited to the business-to-business (B2B) arena. Data on the scope and size of business-to-business transactions on the Internet provide perspective: Compared to B2C volume, the most recent data indicate that B2B activity—transactions by manufacturers and merchant wholesalers—accounted for the most e-commerce (93 percent).4 Manufacturers lead all industry sectors, with e-commerce accounting for 31.2 percent ($1,568 billion) of total shipments, and merchant wholesalers, including manufacturing sales branches and offices, ranked second, with e-commerce accounting for 20.6 percent ($1,148 billion) of total sales.5 In contrast, retail e-commerce, the type of Internet sales with which most consumers are familiar, totaled only $107 billion in 2006.6 As the massive growth in e-commerce continues, significant opportunities and challenges emerge for all firms that market products and services in the business market. Witness the success of Google’s search engine. The Internet is also becoming the main way that managers research B2B purchases.7 For example, instead of lugging 1 George S. Day and Katrina J. Bens, “Capitalizing on the Internet Opportunity,” Journal of Business & Industrial Marketing 20 (4–5, 2005): pp. 160–168. 2Don Peppers and Martha Rogers, Return on Customer (New York: Currency–Doubleday, 2005), p. 42. 3“Dell Business to Business Ecommerce Solutions,” http://www.dell.com/content/topics/reftopic.aspx/pub/commerce, 2008. 4E-Stats: Measuring the Electronic Economy, accessed at http://www.census.gov/estats on May 16, 2008, p. 1. 5Ibid., p. 3. 6Ibid., p. 3. 7Jacob Nielsen, “B-to-B Users Want Sites with B-to-C Service, Ease,” B to B 90 (June 2005): p. 48. Chapter 12 E-Commerce Strategies for Business Markets 305 home piles of brochures from a trade show, prospects look up potential suppliers on the Web to learn more about their products and services. Suppliers must change their communication strategy and develop content for the Web first, and print second—if at all. The Web offers interaction and hypertext and a much better way to communicate complex B2B information tailored to the customer’s situation. Firms that can enter the e-commerce marketplace by leveraging Internet capabilities with information processing, delivery capability, interorganizational collaboration, and flexibility may be able to develop important differential advantages in selected market segments. At the same time, major challenges confront organizations attempting to formulate an e-commerce strategy. These firms must craft a comprehensive e-commerce strategy, radically transform their traditional business models, and deal with rapid changes in e-commerce technology. This chapter examines the nature of e-commerce, the role it can play in the organization’s marketing strategy, the key elements in designing an e-commerce strategy, and the future direction and potential for e-commerce in business marketing. Defining E-Commerce8 E-commerce involves “business communications and transmissions over networks and through computers, specifically the buying and selling of goods and services, and the transfer of funds through digital communications.”9 Who is going to gain an advantage in the customer-empowered, competitive markets that are being reshaped by e-commerce? A recent study suggests that firms that already excel at managing customer relationships were best equipped to capitalize on the opportunities of the Internet. According to the researchers, George S. Day and Katrina J. Bens, “Those leaders were able to anticipate earlier how to use the Internet to connect with their customers, exploited it faster, and implemented the initiative better.” Such best-of-breed relationship builders like Dell, Cisco Systems, FedEx, GE Healthcare, and Johnson Controls relish the prospects presented by e-commerce.10 Alexander Ellinger and his colleagues describe the range of applications that a successful Web site can deliver: Internet applications range from . . . basic sites providing customers with general company information to more complex sites where interactive applications offer customers virtual product catalogs, opportunities to provide feedback, and an array of services including the ability to pay for and fulfi ll orders online. Successful websites add value because of their ability to present fresh, useful, relevant, and comprehensive information. For example, virtual product catalogs on websites are replacing the laborious and expensive necessity of printing and 8Some authors and business marketing experts have suggested that the more appropriate term is e-business, as opposed to e-commerce. They reason that e-commerce is a broad term that deals with all transactions that are Internet-based, whereas e-business specifically refers to transactions and relationships between organizations. In reality, IBM is given credit for coining the term e-business in a major 1997 advertising campaign promoting the notion of e-business. The term was new then but has since become routinely used in the press and marketing campaigns of other companies. This chapter will use e-commerce. 9David J. Good and Roberta J. Schultz, “E-Commerce Strategies for Business-to-Business Service Firms in the Global Environment,” American Business Review 14 (June 2002): p. 111. 10George S. Day and Katrina J. Bens, “Capitalizing on the Internet Opportunity,” p. 164; see also Chuang Ming-Ling and Wade H. Shaw, “A Roadmap for E-Business Implementation,” Engineering Management Journal 17 (June 2005): pp. 3–13. 306 Part IV Formulating Business Marketing Strategy updating the physical catalogs that are customarily used in B-to-B sales. Website content can also make information seeking more convenient for customers. Many firms handle common information requests that would normally require access to a service representative by posting customers’ most frequently asked questions (FAQs) and the associated answers on their websites. A major benefit of interactive web-based content is that it makes the provision of customer service less expensive. For example, self-service B-to-B website applications that allow customers automated access to the overall supply chain require fewer service personnel. Interactive web-based applications also facilitate the customization of service and product offerings for individual accounts, creating potential switching costs for customers and offering firms infinite opportunities to learn more about each customer’s specific requirements and business operations.11 As this discussion suggests, e-commerce is multifaceted and complex. However, the rationale for e-commerce is easy to understand: In certain markets and for selected customers, e-commerce can increase sales volume, lower costs, or provide more real-time information to customers. Ravi Kalkota and Andrew Whinston effectively describe the role of e-commerce for the typical organization: Depending on how it is applied, e-commerce has the potential to increase revenue by creating new markets for old products, creating new informationbased products, and establishing new service delivery channels to better serve and interact with customers. The transaction management aspect of electronic commerce can also enable firms to reduce operating cost by enabling better coordination in the sales, production, and distribution processes (or better supply chain management), and to consolidate operations and reduce overhead.12 In short, e-commerce can be applied to almost all phases of business, with the net effect of creating new demand or making most business processes more efficient. E-commerce can be applied to procuring and purchasing products; managing the process for fulfilling customers’ orders; providing real-time information on the status of orders, online marketing and advertising; creating online product catalogs and product information data sets; managing the logistics process; and processing the payment of invoices.13 The applications are limitless, yet not all products and markets can be effectively served through the e-commerce approach. Later in the chapter we will identify situations that offer the greatest potential for effective application of e-commerce. The different applications of e-commerce are depicted in Figure 12.1. Note that e-commerce can play a pivotal role across all functional areas of the business, yet the most important application from the marketing perspective is how e-commerce facilitates interactions with customers. 11Alexander E. Ellinger, Daniel F. Lynch, James K. Andzulis, and Ronn J. Smith, “B-to-B e-commerce: A Content Analytical Assessment of Motor Carrier Websites,” Journal of Business Logistics 24 (2003): p. 32. 12Ravi Kalkota and Andrew B. Whinston, Electronic Commerce (Reading, MA: Addison-Wesley, 1996), p. 5. 13Ming-Ling and Shaw, “A Roadmap for E-Business,” p. 5. Chapter 12 E-Commerce Strategies for Business Markets FIGURE 12.1 307 TYPES OF E-COMMERCE Interorganizational E-Commerce 1. Supplier management: helps to reduce the number of suppliers, lower procurement costs, and increase order cycle time. 2. Inventory management: instantaneous transmission of information allows reduction of inventory; tracking of shipments reduces errors and safety stock; out-of-stocks are reduced. 3. Distribution management: e-commerce facilitates the transmission of shipping documents and ensures the data are accurate. 4. Channel management: rapid dissemination of information to trading partners on changing market and customer conditions. Technical, product, and pricing information can now be posted to electronic bulletin boards. Production information easily shared with all channel partners. 5. Payment management: payments can be sent and received electronically among suppliers and distributors, reducing errors, time, and costs. Intraorganizational E-Commerce 1. Workgroup communications: e-mail and electronic bulletin boards are used to facilitate internal communications. 2. Electronic publishing: all types of company information, including price sheets, market trends, and product specifications can be organized and disseminated instantaneously. 3. Sales force productivity: e-commerce facilitates information flow between production and the sales force and between the sales force and the customer. Firms gain greater access to market and competitor intelligence supplied by the sales force. Business-to-Customer E-Commerce 1. Product information: information on new and existing products is readily available to customers on the firm’s Web site. 2. Sales: certain products can be sold directly from the firm’s Web site, reducing the cost of the transaction and allowing customers to have real-time information about their order. 3. Service: customers can electronically communicate about order status, product applications, problems with products, and product returns. 4. Payment: payment can be made by the customer using electronic payment systems. 5. Marketing research: firms can use e-commerce, the Internet, and their own Web sites to gather significant quantities of information about customers and potential customers. Key Elements Supporting E-Commerce Intranets and Extranets The Internet has become an important element in the marketing strategy of many business marketers; two other very important technological elements, however, are integrated with an Internet strategy. Intranets are basically company-specific, internal Internets. An intranet links documents on the organization’s scattered internal networks together. A firm’s intranet allows different functions and people to share databases, communicate with each other, disseminate timely bulletins, view proprietary information, be trained in various aspects of the firm’s business, and share any type of information system the company uses to manage its business. For example, 308 Part IV Formulating Business Marketing Strategy INSIDE BUSINESS MARKETING Extending the Boundaries of E-Commerce: B2M (Business to Machines) E-Commerce E-commerce is multifaceted, as suggested by the use of intranets and extranets, and the applications are growing. A creative and relatively new application of e-commerce—business to machine e-commerce (B2M)—can provide huge savings. B2M e-commerce provides data that help Ryder negotiate with the business marketers that provide them with parts and equipment warranties. B2M (Business to Machines) e-Commerce is a fast-emerging area within e-commerce. The general idea is that companies can link to remote machines via the Internet. As an example, consider the $5 billion Ryder Truck Company—Ryder System Inc. When a truck rolls into one of the company’s maintenance bays, the attendant need only push a button to instantly determine the status of that vehicle. Specifically, a technician simply touches a probe located on the end of a handheld computer to a coin-shaped disk on the truck’s cab, capturing information on engine performance and fuel consumption from electronic sensors under the hood. These sensors track information related to 65 different aspects of the truck from oil life and tire wear to filter life, gas mileage, and much more. Prior to the introduction of this B2M system, the company’s mechanics were wrong nearly 50 percent of the time when it came to identifying problems with the trucks. Now the sources of trouble are identified more quickly and a truck’s downtime is often cut in half. The company manages almost 10,000 technicians and 175,000 trucks, but with the B2M system, inventory tracking, parts ordering, maintenance scheduling, and personnel scheduling are streamlined. Additionally, Ryder uses the information it collects on engine-part wear to negotiate longer warranties from suppliers. According to Chief Information Officer Dennis M. Klinger, the new system cost $33 million but reportedly paid for itself in just a few years! SOURCE: “The Many Flavors of E-Commerce,” Accounting Software Advisor, http://www.accountingsoftwareadvisor.com, accessed 2008. Boeing, the world’s largest commercial aircraft manufacturer, maintains a company intranet that is available to more than 200,000 Boeing employees worldwide. One segment of its intranet contains an online course catalog for company educational programs in supervisor training and quality control. Intranets can also incorporate outside news. For example, Factiva, an information company, streams news into enterprise intranets. Much of the external information can be precisely tailored news, relevant to a particular firm.14 Extranets, on the other hand, are links that allow business partners such as suppliers, distributors, and customers to connect to a company’s internal networks (intranets) over the Internet or through virtual private networks. An extranet is created when two organizations connect their intranets for business communications and transactions. The purpose of an extranet is to provide a communication mechanism to streamline business processes that normally take place elsewhere. Hewlett-Packard, for example, has established extranet links to its advertising agencies to speed the review of ad campaigns. Business partners access a company’s intranet by means of a unique password. Companies in the printing industry, for example, allow customers access to their internal networks to track print jobs as they move through production 14Marydee Ojola, “Adding External Knowledge to Business Web Sites,” Online 26 (4, July–August 2002): p. 3. Chapter 12 E-Commerce Strategies for Business Markets 309 or to browse databases of images of other media assets.15 Extranets allow a firm to customize information and interaction with each specific customer who is granted access to its intranet. Hewlett-Packard offers one of the largest medical sites on the Web. To secure customized information, hospital customers have special passwords (based on a profile they provide) that automatically connect them to “special pricing” negotiated through that institution’s contracts with Hewlett-Packard.16 The Strategic Role of E-Commerce For the business marketer, the crucial question is: What role does e-commerce assume in the firm’s overall marketing strategy? One of the great dangers of e-commerce is the potential for managers to become enamored with the technology and ignore the strategic elements and the role of e-commerce in the firm’s overall mission. The Internet and, more specifically, e-commerce are just instruments for accomplishing marketing goals—the need for sound marketing strategy remains. E-Commerce as a Strategic Component The use of e-commerce and, more specifically, the Internet is just like any other element the business marketer uses to accomplish the firm’s mission: It must be focused, based on carefully crafted objectives, and directed at specific target segments. For the marketer, the Internet can be viewed as: 1. a communication device to build customer relationships; 2. an alternative distribution channel; 3. a valuable medium for delivering services to customers; 4. a tool for gathering marketing research data; 5. a method for integrating supply chain members. In short, the Internet usually does not replace existing distribution channels; rather, it supports or supplements them. In a similar way, the Internet does not eliminate the selling function; rather, it facilitates the salesperson’s efforts and enhances the effectiveness and efficiency of the sales function. Likewise, B2B e-commerce should be viewed as an end-to-end business process, involving the entire supply chain.17 According to Hank Barnes, to be successful, business marketers must integrate the Internet and e-commerce into the “fabric of their traditional business operations, leveraging it as a communications tool that can increase sales, satisfaction and service levels.”18 Essentially, e-commerce extends a firm’s reach but does not change the fundamentals of how a firm acquires, responds to, and satisfies its customers. Andy Grove, a legendary Intel executive, aptly concludes, “Implementing the new e-commerce model does not mean simply selling something over the Internet, but incorporating 15“Extranets Enhance Customer Relations,” Graphic Arts Monthly (January 1999): p. 89. 16Curt Werner, “Health Care E-Commerce, Still in Its Infancy, But Growing Fast,” Health Industry Today 8 (September 1998): p. 9. 17Judith Lamont, “Collaborative Commerce Revitalizes Supply Chain,” KM World 14 (July–August 2005): pp. 16–18. 18Hank Barnes, “Getting Past the Hype: Internet Opportunities for B-to-B Marketers,” Marketing News, February 1, 1999, p. 11. 310 Part IV Formulating Business Marketing Strategy INSIDE BUSINESS MARKETING UPS Delivers the Goods Using Sophisticated E-Commerce Technology UPS (United Parcel Service Inc.) is an express carrier, package delivery company, and a global provider of specialized transportation and logistic services. Over more than 90 years, the firm has expanded from a small regional parcel delivery service into a global company. The company’s primary business is the time-definite delivery of packages and documents throughout the United States and more than 200 other countries and territories. UPS is a leading adopter of e-commerce applications, offering new services like UPS online tools and many other service applications to customers through its logistics group at http://www.e-logistics.ups.com and at http://www .upslogistics.com. As the Internet was taking shape, UPS made a financial commitment to transform its operations to meet the changing needs of the digital economy by establishing electronic connectivity with its extensive base of customers. UPS is responding to the challenge of meeting these changing needs as the e-business evolution continues to unfold. The company has a variety of business solutions that give customers productive ways to manage, grow, and even transform their businesses to stay on course in a fast-changing, competitive market. UPS uses a carefully crafted e-commerce strategy to deliver the goods quickly, reliably, and securely. Customers can obtain accurate account and shipping information in real time. Consistently meeting or exceeding service expectations enhances customer satisfaction and loyalty. Every day, UPS links 1.8 million sellers to 7 million buyers all over the world and delivers $1.5 billion worth of packages, including more than 55 percent of all the goods ordered online. The company has formed alliances with the leading e-commerce software providers and helps customers build or improve their Web sites so they, in turn, can better serve their customers. UPS e-Logistics, a subsidiary of UPS, provides integrated, end-to-end supply-chain management services to e-commerce businesses and dot.com divisions of established companies. Whether the customers’ orders come via Web site, phone, mail, or other channel, UPS e-Logistics can manage the entire fulfillment process from inventory management to shipping—providing clients with new capabilities for managing information, moving inventory, and advancing customer loyalty. SOURCE: Nabil Alghalith, “Competing with IT: The UPS Case,” Journal of American Academy of Business 7 (September 2005): pp. 7–15. the Net into the day-to-day functioning of the company, in particular, as a mode for B2B transactions and for building customer relationships.”19 From the perspective of the entire supply chain, a key issue is to include further use of e-commerce to automate and reduce the cost of transactions and to increase the quality of product data flows throughout the supply chain.20 What the Internet Can Do Before exploring the strategic elements of e-commerce, let’s explore the important benefits of an effectively developed e-commerce strategy. The Internet is a powerful tool when used properly, and the advantages are significant in terms of more effectively serving customers, communicating useful information, and lowering the cost of doing business. 19 As quoted in David Troy, “E-Commerce: Foundations of Business Strategy,” Caliber Learning Systems, http://www.caliber.com. 20Aislinn McCormick, “Meeting Global Supply Demands,” Bookseller, September 16, 2005, pp. 12–13. Chapter 12 E-Commerce Strategies for Business Markets 311 The Internet: Strategy Still Matters21 As an important new technology, many executives, entrepreneurs, and investors assumed that the Internet would change everything and render many of the old rules about competition obsolete. Michael Porter, the noted strategist, argues persuasively that the old rules still apply and the fundamentals of strategy remain unchanged. Indeed, caught up in the excitement over Internet technology, many firms—dot-coms and established firms alike—made bad decisions. For example, some firms have shifted the basis of competition toward price and away from traditional factors like quality, features, and service. Under such conditions, all competitors in an industry struggle to turn a profit. Alternatively, other firms forfeited important proprietary advantages by rushing into misguided partnerships and outsourcing relationships. The lesson for business marketers is that the Internet is an enabling technology— a powerful set of tools that complements, rather than replaces, traditional ways of competing. So, the key decision is not whether to use Internet technology, but rather how to deploy it. Successful companies integrate Internet initiatives directly into established operations rather than setting these strategies apart in a specialized e-commerce unit. Michael Porter provides this incisive forecast: Basic Internet applications will become table stakes—companies will not be able to survive without them, but they will not gain any advantage from them. The more robust competitive advantages will arise from traditional strengths such as unique products, proprietary content, distinctive physical activities, superior product knowledge, and strong service and relationships. . . . Ultimately, strategies that integrate the Internet and traditional competitive advantages and ways of competing should win in many industries.22 Enhanced Customer Focus, Responsiveness, and Relationships The Internet allows business marketers to align with their customers on order management and also on product configuration and design, resulting in better customer service and more satisfied customers. Because the Internet creates direct links between customers and factories, corporate buyers can tailor products to meet their exact requirements. Many business marketers now encourage customers to customize products exactly to their specifications right on the Web site. Reduced Transaction Costs When customers use the Internet to communicate with suppliers, the supplier is able to provide low-cost access to both order entry and order tracking 24 hours a day, seven days a week. Transactions that do not require inperson services can be handled in a cost-effective manner on a Web site, and the firm can devote more staff to working with higher-margin customers requiring personal attention. In effect, e-commerce transfers operations to “self-service,” allowing customers to download materials themselves and reducing costs for all involved. Some companies report that by automating transactions over the Internet, the cost of a purchasing transaction has declined from $150 to $25.23 21 This section is based on Michael Porter, “Strategy and the Internet,” Harvard Business Review 79 (March 2001): pp. 63–78. 22Ibid., p. 78. 23Dave Rumar, “Electronic Commerce Helps Cut Transaction Costs, Reduce Red Tape,” Computing Canada 25 (32, 1999): p. 24. 312 Part IV Formulating Business Marketing Strategy Integration of the Supply Chain The Internet allows companies to electronically link far-flung constituencies, including customers, suppliers, intermediaries, and alliance partners, in spite of organizational, geographical, and functional boundaries. All the supply chain participants can be linked by a common database that is shared over the Internet, making the entire value-adding process seamless and more efficient. The key to effective supply chain operations is the sharing of vital information: sales forecasts, production plans, delivery schedules, tracking of finished product shipments through the distribution network, inventory levels at various points in the supply chain, final sales versus planned sales, and the like. QAD, Inc., is the developer of Total eCommerce Solution, which provides a menu of software and services that help companies more consistently integrate global partners into their back-end systems. The Total eCommerce Solution lets users extend supply chain processes to partners, providing the ultimate in business integration. QAD’s services include capabilities for communications, translation, application integration, business process management, and business activity management.24 Focus on Core Business The Internet makes it easier for companies to focus on what they do best and spin off or contract out other operations to third parties that are tied to them through the Internet. In this way, the Internet helps companies develop a “virtual company” that contracts with other firms to perform such functions as manufacturing to warehousing. Boeing developed its latest airplane, the Boeing 777, with a portfolio of relationships among subcontractors and lead customers that were linked electronically.25 This approach allows Boeing to devote more assets and human resources to the critical area of product design. Access Global Markets E-commerce provides a powerful means for B2B firms to penetrate far-flung global markets. Using the latest in IT technology, firms can exploit and expand their customer base all over the world by implementing order and procurement management systems, as well as sales, marketing, and customer support functionality.26 By relying on an e-commerce solution, there is no need to invest in a sales force or “bricksand-mortar” assets in every potential market—the Web provides the necessary coverage. The approach requires a highly effective Internet strategy and the logistics capacity to efficiently make products available to customers in a timely fashion. Once markets are established through e-commerce, the sales volume in a particular geographic area may, in fact, justify the presence of a sales force, offices, and logistics operations. Crafting an E-Commerce Strategy Developing a B2B strategy for e-commerce is no different from developing any other type of marketing strategy. The process begins with an evaluation of the company’s products, customers, competitive situation, resources, and operations to better understand how all of these elements mesh with an e-commerce strategy. Figure 12.2 provides a valuable framework that outlines important strategic and tactical questions 24Renee Boucher Ferguson, “E-com Gets Integration Help,” eWeek, September 9, 2005, pp. 25–35. 25N. Venkatraman and John C. Henderson, “Real Strategies for Virtual Organizing,” Sloan Management Review 40 (Winter 1999): p. 5. 26“E-commerce Market in Asia Still Hot after Dotcom Burst,” Xinhua, July 31, 2002, accessed at WorldSources, Inc., Online. Chapter 12 E-Commerce Strategies for Business Markets FIGURE 12.2 313 QUESTIONS TO GUIDE E-COMMERCE STRATEGY FORMULATION 1. Customers and Markets What are we already doing on the Internet, and how do our activities align with customer needs? How can we use the Internet to provide better customer service? How can we use the Internet to make our sales channels more effective? 2. Competitive Threats How might traditional competitors and e-business startups change market dynamics and take away market share or customers? Will failure to act now precipitate a crisis within the next two years in any of our lines of business? Can we ignore the Internet if our competitors are using it to gain attention and pricing advantages? 3. People and Infrastructure Do our management teams and technical staff have the skills to run an Internet business? What will it cost to fix weaknesses—exposed by our Internet business strategy—in our processes, infrastructure, and enterprise systems? What are appropriate business and financial structures for managing Internet business risk? 4. Sources and Operations Are we blinding ourselves by making assumptions based on our old way of doing business that doesn’t fit with the Internet? What are the Internet-relevant models that match ours, threaten us, or are suitable ways to conduct business? How can we use the Internet to make supply chains more efficient? How can we use the Internet to lower our operating costs? How long will it take? SOURCE: “A CEO’s Internet Business Strategy Checklist: The Leading Questions,” Business Technology Journal—Recent Research, accessed at http:// gartner112.gartnerweb.com on April 19, 1999. that surround e-commerce strategies. Answering these questions helps the business marketing manager to carefully define what the firm hopes to accomplish through an e-commerce strategy and to assess several important resource issues associated with implementing the strategy. Some business marketers find that e-commerce is becoming so sophisticated and technical that they need assistance in both creating and then managing their e-commerce efforts. As a result, many third-party companies have emerged to provide sophisticated solutions to e-commerce applications, and business marketers may find outsourcing an effective strategy. According to Stanford University’s Global Supply Chain Forum, companies using outsourced B2B solutions experience a return nearly 2.5 times their annual investment.27 A recent study showed that outsourced e-commerce strategies led to marked improvements in customer satisfaction. One other tangible benefit of outsourcing e-commerce applications is that using a single B2B solution helps to provide a single focused approach to e-commerce, thus helping to integrate multidivision companies with a common e-commerce vision. 27Frank O. Smith, “Stanford Forum Unearths Big Benefits in B2B Outsourcing,” Manufacturing Business Technology 25 (December, 2007): p. 11. 314 Part IV Formulating Business Marketing Strategy Delineating E-Commerce Objectives A guiding principle in formulating an Internet strategy is to understand that the Internet and the associated technology are nothing more than tools the business marketing strategist uses in satisfying the customer at a profit: “It is not a competitive strategy or the capability to deliver the strategy.”28 Often, there is a temptation to think that the Internet can eliminate the need for salespeople, reduce expenditures on trade advertising, or totally replace traditional distribution channels and marketing intermediaries. For most firms, the Internet supplements the company’s traditional marketing strategy, making it more effective or less costly, or both. In the channels area, for example, many companies find it beneficial to use the Web to support their dealers’ e-business efforts by providing Web-based information to them, offering Web co-op advertising dollars, and allowing the dealers to build a frontend site onto the company’s site.29 Moreover, firms have found that a sales force remains vital in forging customer relationships once an Internet strategy is implemented. In fact, the Internet can make the sales force more productive. For example, PSS WorldMedical is a huge medical products distributor with a sales force of over 700 people. The company developed a closed Customer Link system that allows customers to order products online. The system does not replace the sales force; rather, sales reps continue to earn commissions on Customer Link sales from their accounts. The salespeople can then concentrate more fully on higher-profit capital equipment sales. Synchronizing the Web with Strategy Just as important as enhancing effectiveness and efficiency, the Internet is often used to reach an entirely new or different target market. Many experts consider Dell the “poster child for business-to-business e-commerce” because of its legendary success in controlling costs effectively by providing custom-designed personal computers through the Internet.30 Yet what makes Dell a great Internet marketer is its ability to take its customer-obsessed direct-sales practices and enhance them using the Web. Says Eryn Brown in Fortune, “There isn’t anything the company does online that it doesn’t do in the physical world. Yet Dell and its customers know that nothing beats the Web for taking care of the ‘annoying stuff.’”31 Dell serves as an excellent model for any B2B marketer seeking to fully synchronize an Internet strategy with its traditional salesperson-based strategy. The key to Dell’s success is understanding the Internet’s role and its relationship to all other elements of the firm’s marketing strategy. Specific Objectives of Internet Marketing Strategies The Internet can be effective in providing information as well as in stimulating customer action. Internet marketing objectives resemble those of any type of communication strategy in the business marketplace. The Internet can be used to focus on cognitive objectives like stimulating awareness and knowledge of the company, creating a favorable attitude toward the firm, or stimulating the buyer to purchase. Note the Web site for “Custom-Printed Post-it Notes” displayed in Figure 12.3. In this case, 3M allows the customer to use its Web site to create the exact personalized Post-it note desired. This site also illustrates how easy it is for customers to customize the product to their 28Day and Bens, “Capitalizing on the Internet Opportunity,” p. 167. 29Ginger Conlon, “Direct Impact,” Sales & Marketing Management 151 (December 1999): p. 57. 30Eryn Brown, “Nine Ways to Win on the Web,” Fortune, May 17, 1999, p. 114. 31Ibid., p. 114. Chapter 12 E-Commerce Strategies for Business Markets FIGURE 12.3 315 3M’S WEB SITE MAKES IT EASY TO PERSONALIZE POST-IT NOTES SOURCE: Accessed at http://promote.3m.com/index.jsp;jsessionid=akURBYBb9vN8 on August 8, 2008, Courtesy of 3M. Copyright © 2006 3M; all rights reserved. requirements and place an order online to create the product. By visiting http:// promote.3m.com/index.jsp;jsessionid=akURBYBb9vN8, you can experience firsthand how easy it is to use this online service. The following are some of the most common objectives that business marketers may have for the e-commerce portion of their business:32 1. Target a specific market or group of customers. 2. Build recognition of the company name and brands. 3. Convey a cutting-edge image. 4. Conduct market research. 5. Interact with existing customers and cultivate new ones. 6. Provide real-time information on products, services, and company finances to customers and supply chain partners. 32Adapted from Neal J. Hannon, The Business of the Internet (Cambridge, MA: International Thomson Publishing Company, 1998), p. 210. 316 Part IV Formulating Business Marketing Strategy B2B TOP PERFORMERS GE Healthcare: Using the Web to Create New Services GE Healthcare discovered a way to use the Web to capture data from its medical equipment and create valuable new services for its customers. The resulting service application, called eCenter, monitors and transmits patient data from MRI machines and other GE medical equipment directly to the radiologist (the customer). In addition to enhancing a patient’s care, GE can also provide valuable information that can enhance the productivity of a health-care organization. GE can analyze the data from one customer and compare it to that of other customer sites to see how productive a specific radiology department is compared with others that use the same equipment. Building on the success of this initiative, GE has developed similar eCenter applications for other GE divisions. To illustrate, GE Power Systems customers, such as utilities, can analyze the performance of their turbines versus others in the industry. By viewing information technology as a strategic capability rather than a support function, GE is enhancing its products and cocreating new value with customers. SOURCE: C. K. Prahalad and Venkat Ramaswamy, The Future of Competition: Co-Creating New Value with Customers (Boston: Harvard Business School Press, 2004), p. 223. 7. Sell products and services. 8. Sell in a more efficient manner. 9. Advertise in a new medium. 10. Generate leads for the sales force. 11. Provide a medium for customer service. 12. Build strong relationships with customers. The specific objectives for a firm’s Internet business dictate the issues it must deal with in formulating its strategy. For example, if the objective is to create new sales volume, critical attention must be given to creating systems for handling transactions and providing logistical and service support. Internet strategies vary dramatically based on the objectives. Internet Strategy Implementation With the Internet objectives fully delineated, the business marketer is positioned to develop an Internet strategy. As with any marketing process, the Internet strategy must carefully address product, promotion, channels, and pricing. Discussion of strategy implementation begins by examining the important product-related dimensions. The Internet Product The Internet product is a complex array of physical elements, software, hardware, extranets, intranets, services, and information. The Web site is the major product element in a company’s e-commerce strategy. Even though it may include other dimensions, the heart of an e-commerce strategy is the company’s Web site, for here all interactions with the customer are most cost-effectively handled. Chapter 12 E-Commerce Strategies for Business Markets 317 Text not available due to copyright restrictions As indicated, a Web site has to be developed on the basis of a careful delineation of company objectives, and it is rare that a Web site is developed on the basis of a single objective. Thus, the design of the Web site becomes more complicated as top management articulates additional objectives. Other obvious ingredients in the planning process are the needs of the targeted Web site visitors. A focus on both dimensions assures that both the company and the customer are accommodated. Observe from Figure 12.4 how W. W. Grainger uses its Web site to make it easy for customers to look for products and place an order. If the customer wants to browse through different product lines, that can be done with a single click. For a 318 Part IV Formulating Business Marketing Strategy INSIDE BUSINESS MARKETING “Borrow Best Tactics From Consumer E-Commerce To Revamp Your B2B Site” Stuck in a B2B rut? To boost lead generation and e-Commerce transactions, one marketer looked at best practices in consumer marketing. When they retooled their site, changes included: • Adding lots more images • Creating unique landing pages for top brand name searches • Calculating shipping costs The result is that site traffic increased 587%, and the new lead generation feature created millions of dollars in additional revenue. In turn, new customer segments were identified, such as universities and research labs. When Bob Schneider redesigned the Web site for Ellsworth Adhesives, an industrial adhesive and specialty chemical distributor, his goal was to boost e-commerce sales and lead generation for their field sales reps. But to achieve those B2B goals, Schneider and his team borrowed techniques from the most successful consumer e-commerce sites. “If you aren’t thinking B2C and are just thinking you’re a B2B site, you’re not going to be everything you can be. A lot of the B2B sites that we looked at expected a lot of their users,” says Schneider, the company’s former Webmaster who now consults for Ellsworth Adhesives. B2B purchasers are also consumers, who likely have come to expect certain things from the online shopping experience based on their personal purchases at Amazon.com and other top consumer sites. Keeping those shoppers in mind during the redesign, Schneider’s team applied a consumer focus to the site’s design, content, features, and search engine optimization strategy. Tactic 1. Provide full product information and supporting documents Tactic 2. Calculate actual shipping costs for orders Tactic 3. Show photographs of every product Tactic 4. P r o v i d e e x p e r t s t o a n s w e r questions Tactic 5. Create unique landing pages for top brand name searches Tactic 6. Use negative keywords to filter out consumers SOURCE: Marketing Sherpa, accessed at http://www .marketing sherpa.com/article.php?ident=30113 on August 30, 2007. repetitive order, the customer simply types in the product number and quantity desired. To pick up a product immediately at a Grainger location, the customer only needs to click on “find a branch.” Successful Web Site Design To effectively develop a Web site, the designer needs to think like a user—to anticipate how the customer will use the site and the features that will make it easy to use. To use the Internet as a marketing tool, the Web site should allow customers to easily move along the sales process, provide a quick and easy way to find the product they desire, and determine whether the products fit their needs. If the site can accomplish these goals, then the next function is to ease the financial transaction. Speed, ease of use, and security are central to completing the sales transaction and meeting the customer’s service expectations. Internet Catalogs One of the first applications of e-commerce for many business marketers that sell components, materials, and maintenance and operating resources Chapter 12 E-Commerce Strategies for Business Markets 319 is to develop an electronic catalog on their Web sites. Rather than leafing through thousands of pages, the user can define exact requirements and easily locate the appropriate item in the catalog. Moreover, the catalog can be continuously updated. As Chapter 3 indicated, many firms have embraced e-purchasing applications. They have found that electronic purchasing dramatically enhances the effectiveness of buyers and reduces the time and expense they spend searching for operating resources or nonproduction goods. Firms without Internet catalogs will probably be unable to compete in the future because of the great savings buyers can glean through e-purchasing. Reverse Auctions Reverse auctions, which involve one buyer and many sellers, have been embraced by purchasing managers across business market sectors, including government. Why? Many companies such as Quaker Oats and GlaxoSmithKline report millions of dollars of savings with reverse auctions compared with traditional buying methods. FreeMarkets, Inc.—now a part of Ariba—organizes reverse auctions for manufacturers like United Technologies. Here suppliers bid on purchase contracts for component parts, raw materials, and commodities. Firms that sell commodity items face the greatest threat. Experts suggest that reverse auctions can damage long-standing buyer-seller relationships. Some purchasers have realized that continuously pressing for deeper price cuts might backfire by inhibiting collaboration. If profit margins continually decline, suppliers might be forced to consolidate, thereby enhancing their power.33 Chapter 14 details particular strategies that the business marketer can implement with customers that utilize reverse auctions. Private Exchanges34 A new form of reverse auction has emerged—private exchanges, which are invitation-only networks that connect a single company to its customers, suppliers, or both. Private exchanges can do what open exchanges (reverse auctions) could not: Since they provide secure, one-on-one communication, they enhance shared supply chain processes, such as inventory management, production planning, and order fulfillment. Some suppliers are using the process improvements generated by their participation in exchanges to build closer relationships with customers. Research suggests that private exchanges can offer competitive advantages to most large suppliers if companies understand what these networks offer and what they demand in return. Unlike open B2B marketplaces and industry consortia, private exchanges keep control in the hands of an active participant—an arrangement that helps focus activity on process rather than price. Because suppliers on a private exchange are either invited guests or hosts, buyers have already chosen to do business with them and often have completed price negotiations. In fact, a private exchange is chiefly an information exchange: Though buyers can shop for a better price elsewhere, it has been shown that they are rarely inclined to do so. Customer relationships built on trust (and supported by nondisclosure agreements) are essential if, for example, suppliers are given access to a customer’s sales and inventory information and forecast product demand for that customer, assuring the delivery of goods or services as needed. Private exchanges offer promise for enhancing buyersupplier relationships and for improving the efficiency of supply chains. 33 Sandy D. Jap, “An Exploratory Study of the Introduction of Online Reverse Auctions,” Journal of Marketing 67 ( July 2003): pp. 96–107. 34 William Hoffman, Jennifer Keedy, and Karl Roberts, “The Unexpected Return of B2B,” The McKinsey Quarterly, July 25, 2008, p. 1. 320 Part IV Formulating Business Marketing Strategy Channel Considerations with Internet Marketing Firms that develop an Internet strategy must consider several important distribution channel issues. An Internet marketing presence requires the manager to evaluate the following: the effect on channel efficiencies, current marketing intermediaries, and information sharing among channel members; the ability to rapidly deliver product; and the need to consider the outsourcing of some key channel functions. Channel Efficiencies One significant benefit of B2B Internet marketing is its positive impact on efficiency in the channels of distribution. The Internet uses low-cost communications technology to automate all kinds of business transactions. As a result, much of the back-office paperwork and tasks required in dealing with channel members that once occupied the time of several employees can now be automated. By linking information systems with channel members through the Web, a firm helps intermediaries more effectively monitor inventory and the flow of goods through their warehouses. For example, a large tool distributor uses an e-commerce platform from PartsWatch.35 The architecture enables many innovative benefits like central price updating and automatic catalog updates—without the need to send or receive disks. The primary effect on the channel is that a company has real-time information on demand at every level of distribution. Customers can use the system to direct and manage the channel and efficiently provide real-time central services for all channel partners. These types of networks allow purchase order transactions, order acknowledgments, and shipment notices to flow seamlessly between distributors and their suppliers. Effect on Current Intermediaries Internet strategies pose interesting questions about the structure of a firm’s distribution channel. Depending on the nature of the manufacturer’s Internet strategy, the role of current channel members may be expanded, unchanged, or dramatically reduced. The key variable is how much value the channel member adds to the process of marketing and physically distributing products. In some instances, the channel members may be called on to serve target markets that cannot be effectively covered through an Internet approach. Traditional channel members have often been relegated to the role of serving very small niche markets that cannot be efficiently served through direct or Internet marketing approaches. Others have been able to expand their role because of a manufacturer’s new Internet strategy. Because many Internet transactions involve one or a few items, a real need exists for someone to handle the process of physically fulfilling orders, and hence a new opportunity is presented to a distributor who can perform this function effectively. Disintermediation Because the Internet improves connectivity among firms, it dramatically reduces the cost of communication and coordination in exchange transactions. In a networked channel, firms can bypass intermediaries who have traditionally facilitated the flow of information and goods between firms and their customers. This situation is referred to as disintermediation, and indications are that it is taking hold in several B2B sectors. Large travel agencies that sell airline tickets to corporate accounts are experiencing disintermediation as airlines have created their own Web sites that provide as much or more information to the corporate traveler as did the 35Chris Miller, “E-commerce Advances,” Aftermarket Business 115 (September 2005): p. 14. Chapter 12 E-Commerce Strategies for Business Markets 321 agencies. Itineraries, including hotels, rental cars, and airline tickets, can be arranged with the click of a mouse, and payment can be processed through a secure channel right on the Web site. In fact, because of the success of these Internet strategies, the airlines have reduced or eliminated travel agent commissions, forcing many to either go out of business or focus on leisure travel segments. The Internet as a Channel Alternative The Internet can be a very effective “channel” of distribution for reaching selected target markets. Rarely do business marketers rely solely on the Internet as their only approach for contacting customers and consummating sales. Rather, the Internet is but one channel or method for doing business with target markets. At AMP, the large manufacturer of electronic connectors, its Internet catalog complements traditional channels such as the sales force, distributors, and in-house customer service representatives. The catalog simply gives customers another avenue for doing business with the company.36 In some cases, the Internet is particularly effective for “distributing” certain types of products like software and written material. The software industry pioneered the use of the Internet for product distribution. Computer software firms like Adobe Systems and Microsoft take advantage of the new Web distribution channels to sell and distribute software electronically. The advantage is that companies of any size, with very small marketing budgets, can take advantage of the Web to create and distribute new products. Anything that can be digitized can be transmitted over the Internet, which offers numerous advantages to marketers desiring to distribute printed materials. In short, the Internet broadens the reach of marketers, providing them with an efficient channel to serve customers on a global scale. Digital Channel Advantages By providing an effective mechanism for contacting potential buyers, the Internet offers some advantages over traditional channels of distribution for business products. According to Judy Strauss and Raymond Frost, the Internet adds value for several reasons:37 1. The contact can be customized to the buyer’s needs. 2. The Internet provides a wide range of referral sources such as Web pages, search engines, shopping agents, newsgroups, chat rooms, and e-mail. 3. The Internet is always open for business: Buyers can contact the site 24 hours a day, seven days a week. Using the Internet, business marketers can create customized solutions for customers. For example, Staples (http://www.staples.com) offers customized catalogs for its corporate clients. Such a strategy would be costly to implement through traditional channels. The Internet provides Staples with unparalleled flexibility in creating just the type of catalog a particular organization desires. Other firms have developed 36Jim Kesseler, “Defining the Future of Business-to-Business Electronic Commerce,” Journal of Global Information Management 6 (1, 1999): p. 43. 37Judy Strauss and Raymond Frost, Marketing on the Internet (Upper Saddle River, NJ: Prentice Hall, 1997), p. 168. 322 Part IV Formulating Business Marketing Strategy online stores to more efficiently reach small and medium-sized businesses that are unprofitable for resellers. The Internet channel, if targeted properly and integrated with traditional channel partners, can be a cost-effective approach for serving selected business market segments. The Effect of the Internet on Pricing Strategy By providing buyers with easier access to information about products and suppliers, the Internet bolsters the buyer’s bargaining power. The major impact has been to substantially reduce the business marketer’s control over price. Says Michael Porter, The great paradox of the Internet is that its very benefits—making information widely available; reducing the difficulty of purchasing, marketing, and distribution; allowing buyers and sellers to find and transact business with one another more easily—also makes it more difficult for companies to capture these benefits as profits.38 Where sellers may have enjoyed selected geographical advantages because of the lack of nearby competition, the Internet has opened up markets to many new suppliers, resulting in downward pressure on prices. The pressure on price is particularly severe for any products or services that buyers perceive as “commodities.” These are precisely the types of items for which buyers are using reverse auctions. The net effect is that business marketers of raw materials, components, and supplies that can be priced and sold on the Internet must carefully rethink their pricing approach by developing a more efficient way of competing on price or by creating new serviceenriched offerings that add value in the eyes of potential customers. The Internet and Customer Communication The Internet expands the business marketer’s communication capabilities. Providing real-time, up-to-date, low-cost information is one of the salient features of an Internet strategy. Within seconds and with a few keystrokes, an entire database can be corrected, updated, and appended, and the information can be shared with potential buyers all over the world. The scope of the communications capability of the Internet is illustrated by the different phases of electronic commerce through which companies typically move.39 At the most basic level, a firm might offer simple online information, like their product catalog, facilitating access to information and enhancing product search capabilities. The limitation is the inability to help the user search for information on the basis of predefined criteria—the catalog simply exists in an electronic format. In the next phase of e-commerce, database publishing, the user is provided with search capabilities. Using a search engine, the customer can scan the catalog database and target particular requirements. The third phase, customer self-service, provides customized information for specific users. Here customers can download search-assisted catalogs and service diagnostics, along with information on 38Porter, “Strategy and the Internet,” p. 66. 39Kesseler, “Defining the Future of Business-to-Business Electronic Commerce,” p. 43; see also, D. Eric Boyd and Robert Spekman, “Internet Usage Within B2B Relationships and Its Impact on Value Creation: A Conceptual Model and Research Propositions,” Journal of Business-to-Business Marketing 11 (1–2, 2004): pp. 9–32. Chapter 12 E-Commerce Strategies for Business Markets 323 price and product availability. The final, and most complex, phase of e-commerce, transactions, provides for full transactions, from information gathering to purchase to fulfillment to billing to secure payment, all in a single environment. These categories of Internet communication capability match directly with a recent study of what typical engineers look for when browsing the Web. According to a GlobalSpec Engineering Trends Survey, 91 percent of engineers use the Internet to find components and suppliers, 87 percent use it to obtain product specifications, 72 percent use it for news and information, 68 percent use it for research, 64 percent use it to find pricing information, and 60 percent use it to search for technical application ideas.40 As this study demonstrates, the Internet is a powerful communication tool that can deliver desired information to customers at a critical point in the purchase decision-making process. Meet the Customer’s Requirements Compared with traditional, paper-based approaches, each phase or level of e-commerce improves the way business marketers interact with their customers and potential customers. Reflecting this fact is the recent move of the venerable Thomas Register to online availability only.41 The Thomas Publishing Company will no longer print its multivolume directories—the Thomas Register of American Manufacturers and The Thomas Register of Regional Buying Guides— which have been staples for decades at North American industrial facilities. After 2006, Thomas—which was founded more than 100 years ago—will make these directories available exclusively online at http://www.thomasnet.com. The move to online directories resulted from requests from customers. Increasingly, users were opting against the print format and for the online version because the online directories offer search functionality, immediate access to vendor catalogs, direct links to vendor Web sites, e-commerce capability, and a library of CAD drawings. ThomasNet.com contains information on more than 650,000 manufacturers, distributors, and service companies indexed by 67,000 product and service categories. Of course, Internet communication often merely complements personal contact between buyers and sellers, particularly for complex, expensive products that require customer-specific engineering and customization, extensive negotiations, and long-term contractual arrangements. For example, Boeing’s Web site is used more to describe the company and how it is organized, explain each of its aircraft models, describe and explain the firm’s full range of services, and outline how potential buyers can work with the company in creating a product for their specific requirements. However, for many fi rms that market supplies, standard components, repair parts, and the like, e-commerce provides the greatest potential for reducing transaction costs while making marketing communications more efficient and effective. To recap, the Internet is just one component of the business marketer’s overall strategy: It simply extends the firm’s reach, and it must be integrated into the overarching strategy the firm uses to reach and interact with its customers. Even at Dell, where the firm operates at the phase-four level of e-commerce—full transaction capability—the Internet is just one approach to the marketplace. According to Chairman Michael Dell, “We work with customers face-to-face, on the telephone, 40Greg Jarboe, “Meet The B2B Search Engines,” Search Engine Watch, September 29, 2005, p. 1. 41Sean B. Callahan, “Thomas Plans to Drop Print Directories,” B to B 90 (June 2005): p. 6. 324 Part IV Formulating Business Marketing Strategy or over the Internet. Depending on the customer, some or all of those techniques will be used; they’re all intertwined.”42 The Role of the Sales Force Many firms find that the Internet simply makes sales representatives more effective because they can concentrate on solving customer problems and building customer relationships. The Internet streamlines the sales process and eliminates order-processing details for customers and salespersons alike. Although the Internet will supplant some sales that were once the province of the sales force, Internet strategies generally support sales-force efforts. By using customer relationship management systems (CRM) (see Chapter 4), the salesperson can customize presentations, respond to specific customer idiosyncrasies, and fend off competitive challenges. Successful companies have developed approaches for integrating sales-force strategies with Internet strategies and for compensating salespeople so that they support online initiatives.43 Promotion To capitalize on the investment in creating and maintaining a Web site, promotions highlighting a site need to be run frequently and in a variety of media to stimulate use. An 18-month analysis of small-, medium-, and large-company B2B Web sites indicated that the number of hits is directly related to the amount of offline advertising and sales promotion.44 Advertising in trade publications and handouts at trade shows and conferences appear to be especially effective in stimulating the use of business Web sites. Based on the success of leading search engines like Google and Yahoo, keyword advertising has also become a central element in the promotional budgets of B2B firms—reaching potential customers at a critical point in the purchase decision process. Search-engine marketing and other interactive marketing communication tools are examined in Chapter 15. For business marketers, the Internet provides a powerful vehicle for demonstrating the value of offerings and customizing them for individual customers. Rosabeth Moss Kanter states that e-commerce pacesetters “embrace the Internet as an opportunity for questioning their existing models and experimenting with new ways technology can improve their businesses.”45 Summary Business marketers of all types, whether manufacturers, distributors, or service providers, are integrating the Internet and electronic communications into the core of the business marketing strategies. E-commerce is the broad term applied to communications, business processes, and transactions that are carried out through electronic technology—mainly the Internet. E-commerce can be applied to almost any aspect of business to make all processes more efficient. Based on Internet technologies, an intranet is an internal network accessible only to company employees and other authorized users. By contrast, an extranet is a private network that uses Internet-based 42Financial Times Guide to Digital Business (Autumn 1999), p. 11. 43Stewart Alsop, “E or Be Eaten,” Fortune, November 8, 1999, p. 87. 44Carol Patten, “Marketers Promote Online Traffic through Traditional Media, with a Twist,” Business Marketing 84 (August 1999): p. 40. 45Rosabeth Moss Kanter, “The Ten Deadly Mistakes of Wanna-dots,” Harvard Business Review 79 (January 2001): p. 99. Chapter 12 E-Commerce Strategies for Business Markets 325 technology to link companies with suppliers, customers, and other partners. Extranets allow the business marketer to customize information for a particular customer and to seamlessly share information with that customer in a secure environment. For business marketers, the Internet has been effective as a powerful communication medium, an alternative channel, a new venue for a host of services, a datagathering tool, and a way to integrate the supply chain. To be successful, the Internet strategy must be carefully woven into the fabric of the firm’s overall marketing strategy. The Internet offers important benefits, including reduced transaction costs, reduced cycle time, supply chain integration, access to information, and closer customer relationships. Given the failure of many dot-com companies, the lesson for business marketers is that the Internet is an enabling technology—a powerful set of tools that complements, rather than replaces, traditional ways of competing. The e-commerce strategy must be carefully crafted, beginning with a focus on objectives. Once a firm has established objectives, it can formulate an Internet strategy. Included in the strategy is a consideration of the product-related dimensions of the Internet offering, the most visible of which is the firm’s Web site. Extranets, electronic catalogs, and customer information must also be integrated into the “product.” Several fundamental channel-of-distribution issues must be evaluated, including the effect of the Internet on present channels and channel partners, channel efficiencies, and the Internet as a separate channel to the market. Pricing issues are also significant, particularly in light of the effect of trading communities and auction sites. Finally, marketing communication strategies consider the extent to which the firm provides transactional capabilities on the Web site and how the Internet strategy is integrated with other promotional vehicles. To an important degree, the Internet provides a powerful medium for developing a one-to-one relationship with business market customers. Discussion Questions 1. How do the different definitions of e-commerce apply to the marketing tasks of a typical business marketer? 2. Discuss how Internet buying may lower the cost of procurement for a large company like Raytheon, the manufacturer of business aircraft. 3. What advantages do Internet marketing strategies have over traditional strategies? 4. A large industrial distributor of power transmission equipment embarks on a project to develop an e-commerce strategy. What lessons could it learn from consumer marketers in the design and operation of its Internet site? 5. The Crespy Company makes control systems that regulate large gas turbine engines. Describe the key elements of the Internet product Crespy might develop for its customers. 6. Find a business marketing company’s Web site and evaluate how easy it is for a potential customer to move through the site and eventually purchase a product. 326 Part IV Formulating Business Marketing Strategy 7. What are the key challenges that electronic purchasing via electronic catalogs pose for the typical marketer of office products? 8. Evaluate this statement: The most important determinant of the profit potential of a digital marketplace is the power of buyers and sellers in the particular product arena. Agree or disagree? Explain. 9. Comment on the following: Internet marketing strategies will eventually wipe out most business-to-business intermediaries. 10. Will the Internet result in stiffer price competition in the business-tobusiness marketplace? Explain. Internet Exercise 1. Many B2B firms use Google’s AdWords product as a component of their integrated marketing communications strategy. Go to http:// www.google.com and describe the benefits this product might offer to a B2B firm. Describe how Xerox Corporation might use AdWords to reach prospective customers for its new line of network color printers. CASE Using the Internet at W. W. Grainger W. W. Grainger is one of the largest B2B distributors in the world. With nearly 600 branch locations throughout North America, over 2 million customers, 1,900 customer service associates, and a robust line of 500,000 products (tools, pumps, motors, safety and material handling products, and lighting, ventilation, and cleaning items), Grainger is the leading industrial distributor of products that allow organizations of all types to keep their facilities and equipment running smoothly. Grainger’s objective is to grow by capturing market share in the highly fragmented North American facilities maintenance market. For the longer term, the company is focused on these goals: Accelerate sales growth and increase market share by • capturing a greater share of the business of existing accounts; • targeting high-potential customer segments. Increase operating leverage through • accelerating sales growth; • targeting high-potential customer segments; • reconfiguring the logistics network to improve efficiency and customer service; • enhancing internal processes with technology. Improve return on invested capital by • growing those business units that earn more than the cost of capital; • improving the profitability of business units that earn less than the cost of capital. Its large sales force and product line allow Grainger to meet customer needs in a highly responsive manner. From its nearly 600 branch locations, products can be delivered to customers within hours of a call. In 2008, the company’s major strategic focus was on offering a multichannel approach for purchasing maintenance and operating supplies. This involved providing consistent service through its branches, service centers, and distribution centers. Investments in sales training and a revamped logistics/distribution network were at the heart of this effort. The company’s goal of “zero carryovers”— meaning that all orders received by 5:00 p.m. are shipped that day—is very demanding and provides a severe challenge to regularly achieve. Grainger was recently cited by Industrial Distribution Magazine as “the strongest brand in the industrial distribution industry—because customers believe Grainger can get them what they need when they need it, you can find a Grainger catalog in virtually every purchasing agent’s office in North America.” In 2007, Grainger was ranked 375th on the Fortune 500 list and was included in Fortune’s list of “Most Admired Companies.” 327 328 Part IV Formulating Business Marketing Strategy Discussion Questions 1. What role would the Internet play in Grainger’s strategy, given the firm’s past success, the nature of its product line (rather “‘stodgy” basic industrial items), the organization of the firm (a 500,000-item catalog, a 1,900-person sales force, and 600 branch locations), and 2 million customers? Visit http://www.grainger.com to see the special services that Grainger offers on its Web site. 2. By providing a very brief description of 500,000 items, a Grainger catalog is massive—weighing several pounds. In the past, Grainger executives worried that the catalog could get too heavy for the average person to lift and, therefore, limited product descriptions to a couple of lines. Go to the firm’s Web site, select a particular item, and evaluate the extensive amount of information that is now accessible for each item on the Web. 3. Internet sales for Grainger are the most profitable of all types of sales in its business. In addition, Internet sales account for about 20 percent of its total volume. Explain why Grainger would have such high volume for Internet sales and why these sales are more profitable than those made through conventional methods. CHAPTER 13 Supply Chain Management When suppliers fail to deliver products or services as promised, buyers search for a new supplier. Organizational buyers assign great importance to supply chain processes that eliminate the uncertainty of product delivery. Supply chain management assures that product, information, service, and financial resources all flow smoothly through the entire value-creation process. Business marketers invest considerable financial and human resources in creating supply chains to service the needs and special requirements of their customers. After reading this chapter, you will understand: 1. the role of supply chain management in business marketing strategy. 2. the importance of integrating both firms and functions throughout the entire supply chain. 3. the critical role of logistics activities in achieving supply chain management goals. 4. the importance of achieving high levels of logistics service performance while simultaneously controlling the cost of logistics activities. 329 330 Part IV Formulating Business Marketing Strategy Johnson Controls is a major supplier to the automotive industry of a variety of components, including dashboards, seats, and consoles. For Chrysler’s Jeep Liberty, for example, Johnson Controls supplies complete cockpit modules, seating systems, overhead consoles, and several electronic components. The cockpit module alone consists of 11 major components—from mechanical, electrical, and audio systems to the instrument panel trim. The company integrates parts from 35 suppliers, assembles the complete cockpit, and delivers it to Chrysler as one module—all within what is called the “204-minute broadcast window.” As soon as Chrysler notifies the company that it has received an order for a Jeep Liberty, Johnson Controls has 204 minutes to build and deliver that cockpit to the Chrysler plant 9 miles away with any one of 200 different color and interior combinations or options.1 The company performs that operation 900 times a day, just for that one model. Interestingly, this choreographed supply chain sequence takes place daily at several Johnson Controls plants around the world for a number of auto manufacturers, such as Mercedes, Buick, and Pontiac. How does Johnson Controls make this happen? The firm applies effective supply chain management processes that include (1) integrated computer systems that provide production schedules and demand forecasts to all supply chain members, and (2) collaborative program-management tools that allow manufacturers and suppliers to synchronize activities and respond to events in real time. From the time a component system is engineered to when it is sold, Johnson Controls has adopted processes that tightly connect engineering, manufacturing, procurement, marketing, and sales. Because supply chain partners manufacture components of the firm’s interior modules, Johnson Controls works closely with them to design the right product, at the right cost, and deliver it at the right time. These efforts at Johnson Controls are part of an innovative approach to tightening distribution processes, bolstering links with suppliers and customers, and integrating production and marketing that is referred to as supply chain management (SCM). As new business strategies evolve, SCM is one of the predominant management approaches driving many organizations.2 Bill Copacino, a noted supply chain consultant, puts the importance of SCM in focus:3 In almost every industry, supply chain management has become a much more important strategic and competitive variable. It affects all of the shareholder value levers—cost, customer service, asset productivity, and revenue generation. Yet we are seeing a growing gap in performance between the leading and the average companies. The best are getting better faster than the average companies across almost every industry. For instance, Dell operates with 60 to 100 inventory turns, more than two or three times most of its competitors. So, clearly, the performance gap is widening, and we see this happening in almost every industry segment. The leading supply chain performers are applying new technology, new innovations, and new process thinking to great advantage. The average-performing companies and the laggards have a limited window of opportunity in which to catch up. 1 Lorie Toupin, “Needed: Suppliers Who Can Collaborate throughout the Supply Chain,” Supply Chain Automotive Supplement to Supply Chain Management Review 6 (July–August, 2002): p. 6. 2 Peter C. Brewer and Thomas W. Speh, “Using the Balanced Scorecard to Measure Supply Chain Performance,” Journal of Business Logistics (Spring 2000): p. 75. 3 Bill Copacino, “Supply Chain Challenges: Building Relationships,” Harvard Business Review 81 (July 2003): p. 69. Chapter 13 Supply Chain Management 331 This chapter describes the nature of SCM, explains its important goals, discusses the factors that lead to successful supply chain strategies, and demonstrates how logistics management is a key driver of supply chain success. Once SCM has been defined, the chapter highlights how the business marketer’s logistics processes form the core of the SCM strategy. The logistical elements are described in terms of their interface within the distribution channel and how they must be integrated to create desired customer service standards. The chapter then addresses the role of logistics in purchasing decisions, the types of logistics services buyers seek, and the design of effective logistics processes. The Concept of Supply Chain Management A supply chain encompasses all the activities associated with moving goods from the raw materials stage through to the end user (for example, a personal computer buyer). A formal definition of SCM is: Supply chain management encompasses the planning and management of all activities involved in sourcing and procurement, conversion, and all logistics management activities. Central to SCM are the coordination and collaboration activities performed with channel partners, which may include suppliers, intermediaries, third party service providers, and customers. In essence, supply chain management integrates supply and demand management within and across companies.4 The supply chain includes a variety of firms, ranging from those that process raw materials to make component parts to those engaged in wholesaling. Included also are organizations engaged in transportation, warehousing, information processing, and materials handling. The critical processes involved in SCM include the following: 1. Customer Relationship Management 2. Supplier Relationship Management 3. Customer Service Management 4. Demand Management 5. Order Fulfillment 6. Manufacturing Flow Management 7. Product Development and Commercialization 8. Returns Management5 Successful SCM coordinates and integrates these processes into a seamless level of performance. Effective supply chain management requires the careful integration of these processes across several different organizations in the supply chain. 4 CSCMP Definition of Supply Chain Management, accessed at http://cscmp.org/aboutcscmp/definitions/definitions.asp, August 2008. 5 Douglas Lambert (ed.), Supply Chain Management (Sarasota, FL: Supply Chain Management Institute, 2008), p. 10. 332 Part IV Formulating Business Marketing Strategy Importantly, supply chain management can improve overall company performance in two fundamental ways: revenue enhancement and cost reduction. Supply chain management can—and should—play an important role in each of those areas. For example, supply chain management can play a leadership role in creating a more responsive supply chain, thereby helping the company to win more business (and increase revenues) from customers. Similarly, supply chain management can take the lead in applying good processes to better manage and lower costs across the entire enterprise, not just those typically assigned to procurement, manufacturing, or logistics.6 Supply chains should be managed in an integrated manner. Integrated SCM focuses on managing relationships, information, and material flow across organizational borders to cut costs and enhance flow. When the multicompany nature of the supply chain focus is combined with a process-flow approach to business, the critical role that SCM assumes becomes clear. Rather than merely handling order fulfillment, SCM is instrumental in a full range of activities from product development and new-product-launch strategies to fulfillment and recycling. To that end, SCM must be fully integrated into business strategy and fine-tuned throughout the product’s life cycle.7 Leading supply chain–oriented firms focus intensely on monitoring actual user demand instead of forcing into markets products that may or may not sell quickly. In so doing, they minimize the flow of raw materials, finished product, and packaging materials, thereby reducing inventory costs across the entire supply chain. Partnerships: The Critical Ingredient Thomas Stalkamp, former CEO of Chrysler, notes that many old-line U.S. industrial firms are hampered by the fact that the atmosphere between the parties in supply chains is more adversarial than it needs to be. He refers to this old-line, nonintegrated approach to business as “adversarial commerce.”8 Fueling the movement to SCM has been the recognition by many firms that adversarial commerce is costly and limits the ability of all supply chain members to compete in the global marketplace. Integrating activities across the supply chain requires close working relationships. SCM may require that all firms in the supply chain share sensitive and proprietary information about customers, actual demand, point-of-sale transactions, and corporate strategic plans. SCM involves significant joint planning and communication; firms often create teams of personnel that cut across functional and firm boundaries to coordinate the movement of product to market. In other words, achieving the real potential of SCM requires integration not only among departments within the organization but also with external partners. A wonderful example of the effect of integration among supply chain partners is the case of Avnet, a huge electronics distributor. Avnet developed a program to integrate its supply chain processes with those of a major manufacturer supplier and with the major component supplier to that manufacturer. By sharing demand and production information, the participants raised on-time delivery from 80 percent to 6 Robert A. Rudzki, “Supply Chain Management Transformation: A Leader’s Guide,” Supply Chain Management Review 12 (March, 2008): p. 14. 7 Laura Rock Kopczak and M. Eric Johnson, “The Supply Chain Management Effect,” MIT Sloan Management Review 44 (Spring 2003): p. 28. 8 Thomas T. Stallkamp, “Ending Adversarial Commerce,” Supply Chain Management Review 9 (October 2005): pp. 46–52. Chapter 13 Supply Chain Management 333 100 percent of all orders, increased inventory turnover by a factor of 5, and tripled the return on materials! The collaboration of all supply chain partners is required to achieve such performance results. Traditional, nonintegrated approaches to managing product and information flows are expensive and time-consuming. Such approaches often involve much higher transportation and handling costs, and they demand considerable time from salespeople, buyers, and others in the organization. For example, material is often moved around too much—one major computer manufacturer reported that some of the components it used had traveled 250,000 miles before they reached the ultimate buyer. Furthermore, traditional transactions processes create excess inventory in the pipeline leading to the customer. In the pharmaceutical industry, for example, firms that have not adopted SCM incur higher inventory-carrying costs and provide lower levels of customer service than their competitors. Firms and their suppliers can create highly competitive supply chains by collaborating. Failure to collaborate can result in inefficiencies such as increases in material cost, distortion of information as it moves through a supply chain, or slow response to product design and development. By entering into long-term supply chain partnerships, firms can eliminate many of these problems and ensure ongoing improvement.9 Until some type of partnership is in place, the true benefits of supply chain integration cannot be achieved. Dell, for example, strives to maintain long-term relationships with high-reliability suppliers, such as Sony, so that items like monitors can be shipped from the supplier (Sony’s factory) directly to the customer. The result is that Dell is able to fulfill customer orders in real time.10 Industry experts recognize Dell as an elite performer in SCM.11 Not only do effective supply chains conduct business as partners, they also openly share information. Intelligence about the customer and what the customer has ordered is transmitted upstream so that every organization in the supply chain has it and can respond accordingly. When information is made immediately available to supply chain members, Tier 1 and Tier 2 suppliers can act immediately, eliminating the delays that created inefficiencies in the past. This allows the supply chain to reduce inventories (safety stocks) and speed up cash flow. Figure 13.1 depicts the stages that companies go through when forming intercompany networks. Note that in Stage 3, the “Extended Enterprise,” companies have successfully aligned both their internal and external processes. This is the ultimate goal of SCM. Supply Chain Management: A Tool for Competitive Advantage The supply chain can be a powerful competitive weapon, as market leaders like Dell, Grainger, and Hewlett-Packard have demonstrated. Other best-in-class supply chain performers include Johnson Controls, Inc. ( JCI), profiled at the outset of this chapter, and Motorola. In recognizing Johnson Controls as a world-class supply chain performer, AMR Research observed: “JCI’s continued success proves demand-driven supply chain 9 Anupam Agrawal and Arnoud De Meyer, “Managing Value in Supply Chain—Case Studies on Alternate Structures,” INSEAD Working Papers Collection (28, 2008): p. 1. 10 S. Chopra and J. A. Van Mieghan, “Which e-Business Is Right for Your Supply Chain?” Supply Chain Management Review 4 (July–August 2000): p. 34. 11 Thomas A. Stewart and Louise O’Brien, “Execution Without Excuses,” Harvard Business Review 83 (March 2005): p. 110. 334 Part IV Formulating Business Marketing Strategy FIGURE 13.1 STAGES FIRMS GO THROUGH IN ADOPTING SUPPLY CHAIN MANAGEMENT The Supply Chain Stages Stage 3 The Expanded Enterprise Stage 2 Internal Process Integration Stage 1 Functional Plan Source Stage 0 Informal Functional orientation suboptimizes enterprise performance in asset management, cost, and customer satisfaction. The lack of functional policies/processes and basic operations management results in unpredictable product quality and supply. Make Deliver With alignment across all subprocesses and levels of management, operations management processes are integrated and display world-class performance and continuous improvement. There is internal and external process integration, allowing each enterprise to focus on its customers and core competencies and on creating value. SOURCE: Tom Brunell, “Managing a Multicompany Supply Chain,” Supply Chain Management Review (Spring 1999): p. 49. Reprinted with permission of Supply Chain Management Review, a Cahners publication. can work anywhere in the supply chain, provided outside-in thinking is applied from the customer backward into manufacturing and engineering.”12 For Motorola, incorporating supply chain management into all phases of the design, sourcing, manufacturing, and distribution processes helped the company to enhance its market position across sectors. Supply chain management is now recognized by Motorola’s top management as an important source of competitive advantage and shareholder value creation.13 As a primary interface point with the customer, SCM can offer value in the form of competitively superior delivery and value-added services, as defined by customers. Best-in-class SCM practices provide advantages, including 10 to 30 percent higher on-time delivery performance, a 40 to 65 percent (or 1- to 2-month) advantage in cash-to-cash cycle time, and 50 to 80 percent less standing inventory, which all translates into 3 to 6 percent of a company’s revenue. For a $100 million company, earnings improvements of up to $6 million are achievable by thoroughly adopting SCM practices.14 However, SCM, as a source of competitive advantage, is not simply a way to reduce cost, but also a way to boost revenues.15 12 Tony Friscia, Kevin O’Marah, Debra Hofman, and Joe Souza, “The AMR Research Supply Chain Top 25 for 2007,” accessed at http://www.amrresearch.com/content/ on May 31, 2007. 13 William Hoffman, “Squeezing Supply Chains,” Traffic World 127 ( July 7, 2007): p. 16. 14 Bill Faherenwald, “Supply Chain: Managing Logistics for the 21st Century,” Business Week, December 28, 1998, Special Section, p. 3. 15 Charles Batchelor, “Moving Up the Corporate Agenda,” The Financial Times, December 1, 1998, p. 1. Chapter 13 Supply Chain Management 335 Supply Chain Management Goals SCM is both a boundary- and function-spanning endeavor. The underlying premise of SCM is that waste reduction and enhanced supply chain performance come only with both intrafirm and interfirm functional integration, sharing, and cooperation. Thus, each firm within the supply chain must tear down functional silos and foster true coordination and integration of marketing, production, procurement, sales, and logistics. Furthermore, actions, systems, and processes among all the supply chain participants must be integrated and coordinated. Firmwide integration is a necessary, but not sufficient, condition for achieving the full potential benefits of SCM. Integration must be taken to a higher plane so that functions and processes are coordinated across all the organizations in the supply chain. SCM is undertaken to achieve four major goals: waste reduction, time compression, flexible response, and unit cost reduction.16 These goals have been articulated in several contexts associated with SCM, and they speak to the importance of both interfunctional and interfirm coordination. Waste Reduction Firms that practice SCM seek to reduce waste by minimizing duplication, harmonizing operations and systems, and enhancing quality. With respect to duplication, firms at all levels in the supply chain often maintain inventories. Efficiencies can be gained for the chain as a whole if the inventories can be centralized and maintained by just a few firms at critical points in the distribution process. With a joint goal of reducing waste, supply chain partners can work together to modify policies, procedures, and data-collection practices that produce or encourage waste.17 Typically, waste across the supply chain manifests itself in excess inventory. Effective ways to address this are through postponement and customization strategies, which push the final assembly of a completed product to the last practical point in the chain. Dell provides an excellent illustration of how to reduce waste through effective “waste” management strategies. The company’s build-to-order model produces a computer only when there is an actual customer order. Dell works with its suppliers to achieve a system where inventory turns are measured in hours rather than days. Because Dell does not maintain stocks of unsold finished goods, it has no need to conduct “fire sales.” The result: Waste has been eliminated both on the component side and on the finished-goods side. Time Compression Another critical goal of SCM is to compress order-to-delivery cycle time. When production and logistics processes are accomplished in less time, everyone in the supply chain is able to operate more efficiently, and a primary result is reduced inventories throughout the system. Time compression also enables supply chain partners to more easily observe and understand the cumulative effect of problems that occur anywhere in the chain and respond quickly. Reduced cycle time also speeds the cash-to-cash cycle for all chain members, enhancing cash flow and financial performance throughout the system. Time compression means that information and products flow smoothly and quickly, thus permitting all parties to respond to customers in a timely manner while maintaining minimal inventory. Many industrial distributors like W.W. Grainger have designed supply chains that are able to respond 16 Brewer and Speh, “Using the Balanced Scorecard,” p. 76. 17 Kate Vitasek, Karl B. Manrodt, and Jeff Abbott, “What Makes a LEAN Supply Chain?” Supply Chain Management Review 9 (October 2005): pp. 39–45. 336 Part IV Formulating Business Marketing Strategy to customer orders with “same-day” delivery, allowing customers to reduce inventories and to rest assured that timely delivery support is available to solve unexpected problems. Flexible Response The third goal of SCM is to develop flexible response throughout the supply chain. Flexible response in order handling, including how orders are handled, product variety, order configuration, order size, and several other dimensions, means that a customer’s unique requirements can be met cost-effectively. To illustrate, a firm that responds flexibly can configure a shipment in almost any way (for example, different pallet patterns or different product assortments) and do it quickly without problems for the customer. Flexibility also may mean customizing products in the warehouse to correspond to a customer’s need for unique packaging and unitization. The key to flexibility is to meet individual customer needs in a way that the customer views as cost-effective and the supply chain views as profitable. Unit Cost Reduction The final goal of SCM is to operate logistics in a manner that reduces cost per unit for the end customer. Firms must determine the level of performance the customer desires and then minimize the costs of providing that service level. The business marketer should carefully assess the balance between level of cost and the degree of service provided. The goal is to provide an appropriate value equation for the customer, meaning that cost in some cases is higher for meaningful enhancements in service. Cost cutting is not an absolute, but the SCM approach is focused on driving costs to the lowest possible level for the level of service requested. For example, shipping product in full truckload quantities weekly is less expensive than shipping pallet quantities every day; however, when a customer like Honda wants daily deliveries to minimize inventories, the SCM goal is to offer daily shipments at the lowest possible cost. SCM principles drive down costs because they focus management attention on eliminating activities that unnecessarily add cost, such as duplicate inventories, double and triple handling of the product, unconsolidated shipments, and uncoordinated promotions, such as special sales. Hau Lee, an internationally recognized expert, points out that supply chain efficiency is necessary, but it is not enough to ensure that firms do better than their rivals. Only companies that build agile, adaptable, and aligned supply chains get ahead of the competition.18 Efficient supply chains often become uncompetitive because they do not adapt to changes in market structures: Supply chains need to keep adapting so they can adjust to changing customer needs. In addition, low-cost supply chains are not always able to respond to sudden and unexpected changes in markets—like a shift in resource availability or the effect of a natural disaster. Finally, excellent supply chain companies align the interests of all the firms in their supply chain with their own—if any company’s interests differ from those of the other organizations in the supply chain, its actions do not maximize the chain’s performance. Benefits to the Final Customer A well-managed supply chain ultimately creates tangible benefits for customers throughout the supply chain. When the supply chain reduces waste, improves cycle 18 Hau L. Lee, “The Triple-A Supply Chain,” Harvard Business Review 82 (October 2004): pp. 102–112. Chapter 13 Supply Chain Management 337 INSIDE BUSINESS MARKETING When the Chain Breaks It began on a stormy evening in New Mexico in March 2000 when a bolt of lightning hit a power line. The temporary loss of electricity knocked out the cooling fans in a furnace at a Philips semiconductor plant in Albuquerque. A fire started, but was put out by staff within minutes. The damage seemed to be minor: eight trays of wafers containing the miniature circuitry to make several thousand chips for mobile phones had been destroyed. After a good clean-up, the company expected to resume production within a week. That is what the plant told its two biggest customers, Sweden’s Ericsson and Finland’s Nokia, who were vying for leadership in the booming mobile-handset market. Nokia’s supplychain managers had realized within two days that there was a problem when their computer systems showed some shipments were being held up. Delays of a few days are not uncommon in manufacturing and a limited number of back-up components are usually held to cope with such eventualities. But whereas Ericsson was content to let the delay take its course, Nokia immediately put the Philips plant on a watch list to be closely monitored in case things got worse. They did. Semiconductor fabrication plants have to be kept spotlessly clean, but on the night of the fire, smoke and soot had contaminated a much larger area of the plant than had first been thought. Production would be halted for weeks. By the time the full extent of the disruption became clear, Nokia had already started locking up all the alternative sources for the chips. That left Ericsson with a serious parts shortage. The company, having decided some time earlier to simplify its supply chain by single-sourcing some of its components, including the Philips chips, had no plan B. This severely limited its ability to launch a new generation of handsets, which in turn contributed to huge losses in the Swedish company’s mobile-phone division. This has become a classic case study for supply-chain experts and risk consultants. SOURCE: Adapted from “When the Chain Breaks,” The Economist, 379 (June 17, 2006): p. 18. Parts of this article were taken from Yossi Sheffi, The Resilient Enterprise, (Boston: MIT Press, 2005) and Martin Christopher, Logistics and Supply Chain Management (London: Financial Times Prentice Hall, 2005). time and flexible response, and minimizes costs, these benefits should flow through to ultimate customers. Thus, a key focus of the supply chain members is monitoring how much the customer is realizing these important benefits and assessing what may be preventing them from doing so. A supply chain’s customer can be viewed on several dimensions, and it is important to focus on each. A producer of electronic radio parts views the radio manufacturer as an absolutely critical customer, but the auto manufacturer that installs the radio in a car is equally important, if not more so, and ultimately the final buyer of the automobile must be satisfied. Thus, different demands, desires, and idiosyncrasies of customers all along the supply chain must be understood and managed effectively. As the Inside Business Marketing example at the Phillips semiconductor plant suggests, uncontrollable events can create havoc in a supply chain, and both suppliers and customers need to focus attention on creating detailed contingency plans for overcoming unplanned disruptions. The Financial Benefits Perspective Innovative supply chain strategies that couple physical goods movement with financial information sharing can open the door to greater end-to-end supply chain cost 338 Part IV Formulating Business Marketing Strategy savings, better balance sheets, lower total costs, higher margins, and a more stable supply chain with everyone sharing the savings.19 When supply chain partners are achieving their goals and the benefits are flowing through to customers, supply chain members should succeed financially. The most commonly reported benefits for firms that adopt SCM are lower costs, higher profit margins, enhanced cash flow, revenue growth, and a higher rate of return on assets. Because activities are harmonized and unduplicated, the cost of transportation, order processing, order selection, warehousing, and inventory is usually reduced. A study to validate the correlation between supply chain integration and business success shows that best-practice SCM companies have a 45 percent total supply chain cost advantage over their median supply chain competitors.20 Cash flows are improved because the total cycle time from raw materials to finished product is reduced. The leading firms also enjoy greater cash flow—they have a cash-to-order cycle time exactly half that of the median company. On the other hand, recent evidence suggests that the stock market punishes firms that stumble in SCM. For example, one study showed that supply chain glitches can result in an 8.6 percent drop in stock price on the day the problem is announced and up to a 20 percent decline within 6 months.21 Information and Technology Drivers Supply chains could not function at high levels of efficiency and effectiveness without powerful information systems. Many of the complex Internet supply chains maintained by companies like Hewlett-Packard and Cisco could not operate at high levels without sophisticated information networks and interactive software. The Internet—and Internet technology—is the major tool business marketers rely on to manage their lengthy and integrated systems. In addition, a host of software applications play a key role in helping a supply chain operate at peak efficiency. Supply Chain Software SCM software applications provide real-time analytical systems that manage the flow of products and information through the supply chain network.22 Of course, many supply chain functions are coordinated, including procurement, manufacturing, transportation, warehousing, order entry, forecasting, and customer service. Much of the software is focused on each one of the different functional areas (for example, inventory planning or transportation scheduling). However, the trend is to move toward software solutions that integrate several or all of these functions. The result is that firms can work with a comprehensive “supply chain suite” of software that manages flow across the supply chain while including all of the key functional areas. Several firms producing Enterprise Resource Planning (ERP) software—such as SAP or Oracle—have developed applications that attempt to integrate functional areas and bridge gaps across the supply chain. 19 Aura Drakšaitė and Vytautas Snieška, “Advanced Cost Saving Strategies of Supply Chain Management in Global Markets,” Economics and Management (2008): p. 113 20 Brad Ferguson, “Implementing Supply Chain Management,” Production and Inventory Management Journal (Second Quarter, 2000): p. 64. 21 Robert J. Bowman, “Does Wall Street Really Care about the Supply Chain?” Global Logistics and Supply Chain Strategies (April 2001): pp. 31–35. 22 Steven Kahl, “What’s the ‘Value’ of Supply Chain Software?” Supply Chain Management Review 3 (Winter 1999): p. 61. Chapter 13 Supply Chain Management 339 SCM software creates the ability to transmit data in real time and helps organizations transform supply chain processes into competitive advantages. Equipping employees with portable bar code scanners that feed a centralized database, FedEx is a best-practices leader at seamlessly integrating a variety of technologies to enhance all processes across an extended supply chain.23 The company uses a real-time data transmission system (via the bar code scanners used for every package) to assist in routing, tracking, and delivering packages. The information recorded by the scanners is transmitted to a central database and is made available to all employees and customers. Each day FedEx’s communications network processes nearly 400,000 customer service calls and tracks the location, pickup time, and delivery time of 2.5 million packages! FedEx is electronically linked so tightly with some customers that when the customer receives an order, FedEx’s server is notified to print a shipping label, generate an internal request for pickup, and then download the label to the customer’s server. The label, with all the needed customer information, is printed at the customer’s warehouse and applied to the package just before FedEx picks it up. This tight electronic linkage adds significant efficiency to the customer’s supply chain process and allows FedEx to deliver on its promises.24 Successfully Applying the Supply Chain Management Approach The nature of the firm’s supply chain efforts often depends on the nature of the demand for its products. Marshall Fisher suggests that products can be separated into two categories: “functional” items, like paper, maintenance supplies, and office furniture, for example; or “innovative” items, like cell phones, the BlackBerry, or other high-tech products. The importance of this distinction is that functional items require different supply chains than do innovative products.25 Functional products typically have predictable demand patterns, whereas innovative products do not. The goal for functional products is to design a supply chain with efficient physical distribution; that is, it minimizes logistics and inventory costs and assures low-cost manufacturing. Here, the key information sharing takes place within the supply chain so that all participants can effectively orchestrate manufacturing, ordering, and delivery to minimize production and inventory costs. Innovative products, on the other hand, have less predictable demand, and the key concern is reacting to short life cycles, avoiding shortages or excess supplies, and taking advantage of high profits during peak demand periods. Rather than seeking to minimize inventory, supply chain decisions center on the questions of where to position inventory, along with production capacity, in order to hedge against uncertain demand. The critical task is to capture and distribute timely information on 23 Sandor Boyson and Thomas Corsi, “The Real-Time Supply Chain,” Supply Chain Management Review 5 (January– February 2001): p. 48. 24 For a related discussion, see Pierre J. Richard and Timothy M. Devinney, “Modular Strategies: B2B Technology and Architectural Knowledge,” California Management Review 47 (Summer 2005): pp. 86–113. 25 Marshall Fisher, “What Is the Right Supply Chain for Your Product?” Harvard Business Review 75 (March–April 1997): p. 106. 340 Part IV Formulating Business Marketing Strategy B2B TOP PERFORMERS Making Supplier Relationships Work During the past decade, Toyota and Honda have struck remarkable partnerships with some of the same suppliers who describe their relationships with the Big Three U.S. automakers as adversarial. Of the 2.1 million Toyota/Lexuses and the 1.6 million Honda/Acuras sold in North America in 2003, Toyota manufactured 60 percent and Honda 80 percent in North America. Moreover, the two companies source about 70 to 80 percent of the costs of making each automobile from North American suppliers. Despite the odds, Toyota and Honda have managed to replicate in an alien Western culture the same kind of supplier webs they developed in Japan. Consequently, they enjoy the best supplier relations in the U.S. automobile industry, have the fastest product development processes, and reduce costs and improve quality year after year. Toyota claims that over 60 percent of its innovations come from ideas provided by their suppliers! Hence, they understand the importance of maintaining excellent supplier relationships. Both firms: • understand how their suppliers work and develop deep knowledge of the degree of efficiency and effectiveness that particular suppliers demonstrate. • turn supplier rivalry into an opportunity by rewarding quality, innovation, and costreduction initiatives. • actively supervise suppliers and help them improve their operational capabilities. • continuously and intensively share information with suppliers. • conduct joint improvement activities to advance mutual goals. Rather than excelling on one dimension, Toyota and Honda win by applying all of them as a system for continuously improving supplier relationships. SOURCE: Jeffrey K. Liker and Thomas Y. Choi, “Building Deep Supplier Relationships,” Harvard Business Review 82 (December 2004): pp. 104–113. customer demand to the supply chain. When designing the supply chain, firms should concentrate on creating efficient processes for functional products and responsive processes for innovative products. Successful Supply Chain Practices Most successful supply chains have devised approaches for participants to work together in a partnering environment. Supply chains are not effective and, in reality, are not supply chains when the participants are adversaries. Supply chain partnerships form the foundation. Highly effective supply chains feature integrated operations across supply chain participants, timely information sharing, and delivering added value to the customer. As testimony to the importance of supply chain partnerships, the Malcolm Baldrige National Quality Award Committee recently made “key supplier and customer partnering and communication mechanisms” a separate category it would use to recognize the best companies in the United States.26 In considering the economic value created across the supply chain, one expert observes, “You should 26 Jeffrey K. Liker and Thomas Y. Choi, “Building Deep Supplier Relationships,” Harvard Business Review 82 (December 2004): p. 104. Chapter 13 Supply Chain Management 341 go for the best return on net assets for the supply chain, and trade off costs between income statements and balance sheets to see that everybody shares in that gain.”27 For the supply chain partners to work as a unit, this enlightened perspective of collaboration is mandatory. For the supply chain partnership to succeed, the partners need to clearly define their strategic objectives, understand where their objectives converge (and perhaps diverge), and resolve any differences.28 Because the supply chain strategy drives all the important processes in each firm as well as those that connect the firms, managers in both organizations must participate in key decisions and support the chosen course. Once key participants specify and endorse supply chain strategies, performance metrics can be established to track how well the supply chain is meeting its common goals. The metrics used to measure performance are tied to the strategy and must be linked to the performance evaluation and reward systems for employees in each of the participating firms. Without this step, individual managers would not be motivated to accomplish the broad goals of the supply chain. Logistics as the Critical Element in Supply Chain Management Nowhere in business marketing strategy is SCM more important than in logistics. Logistics management is that part of supply chain management that plans, implements, and controls the efficient, effective forward and reverse flow and storage of goods, services and related information between the point of origin and the point of consumption in order to meet customers’ requirements. Logistics management activities typically include inbound and outbound transportation management, fleet management, warehousing, materials handling, order fulfillment, logistics network design, inventory management, supply/demand planning, and management of third-party logistics services providers. To varying degrees, the logistics function also includes sourcing and procurement, production planning and scheduling, packaging and assembly, and customer service. It is involved in all levels of planning and execution—strategic, operational and tactical. Logistics management is an integrating function, which coordinates and optimizes all logistics activities, as well as integrates logistics activities with other functions including marketing, sales, manufacturing, finance, and information technology.29 Effective business marketing demands efficient, systematic delivery of finished products to channel members and customers. The importance of this ability has elevated the logistics function to a place of prominence in the marketing strategy of many business marketers. 27 Richard H. Gamble, “Financing Supply Chains,” businessfinancemag.com (June 2002): p. 35. 28 Peter C. Brewer and Thomas W. Speh, “Adapting the Balanced Scorecard to Supply Chain Management,” Supply Chain Management Review 5 (March–April 2001): p. 49. 29 CSCMP Definition of Logistics, accessed at http://cscmp.org/aboutcscmp/definitions/definitions.asp on August 2008. 342 Part IV Formulating Business Marketing Strategy FIGURE 13.2 SUPPLY CHAIN FOR ELECTRIC MOTORS Transportation Transportation Iron Ore Mining Steel Fabrication Transportation Parts Manufacturers Electric Motor Manufacturer Transportation Warehousing C U S T O M E R Warehousing DISTRIBUTOR Transportation Warehousing Distinguishing Between Logistics and Supply Chain Management Logistics is the critical element in SCM. In fact, there is considerable confusion over the difference between the discipline of SCM and logistics. As our definition stated, SCM is focused on the integration of all business processes that add value for customers. The 1990s witnessed the rising importance of time-based competition, rapidly improving information technology, expanding globalization, increasing attention to quality, and the changing face of interfirm relationships. These trends combined to cause companies to expand their perspective on logistics to include all the firms involved in creating a finished product and delivering it to the buyer or user on time and in perfect condition. For example, the supply chain for electric motors would include raw material suppliers, steel fabricators, component parts manufacturers, transportation companies, the electric motor manufacturer, the distributor of electric motors, the warehouse companies that store and ship components and finished products, and the motor’s ultimate buyer. Figure 13.2 graphically depicts such a supply chain. The SCM concept is an integrating philosophy for coordinating the total flow of a supply channel from supplier to ultimate user. Logistics is critical, however, to business marketers, because regardless of the orientation to the entire supply chain, the firm relies on its logistics system to deliver product in a timely, low-cost manner. Managing Flows The significance of the supply chain perspective in logistical management is that the business marketing manager focuses attention on the performance of all participants in the supply chain. The manager also coordinates their efforts to enhance the timely delivery of the finished product to the ultimate user at the lowest possible cost. Inherent in the supply chain approach is the need to form close relationships with the supply chain participants, including vendors, transportation suppliers, warehousing companies, and distributors. The focus of logistics in the SCM for business marketers is the flow of product through the supply chain, with timely information driving the entire process. Product flow in the reverse direction is also important in business supply chains. Many companies, like Xerox and Canon, routinely remanufacture products that are worn out or obsolete. Effective linkages and processes must be in place to return such products to a facility in order to remanufacture or retrofit them. If the reverse supply Chapter 13 Supply Chain Management 343 chains are operating effectively, companies can sometimes realize higher margins on the remanufactured products than they do on new items.30 The Strategic Role of Logistics In the past, logistics was viewed simply as a cost of doing business and a function whose only goal was higher productivity. Today, many companies view logistics as a critical strategic weapon because of its tremendous effect on a customer’s operation. For many business marketers, logistics is their primary marketing tool for gaining and maintaining competitive superiority. These firms typically recognize that logistics performance is an important part of marketing strategy, and they exploit their logistics competencies. Companies that incorporate logistics planning and management into long-term business strategies can achieve significant benefits, which create real value for the company. Nucor Steel enjoys strong customer loyalty because it can deliver steel to a construction site within a 2- to 4-hour window and offload the truck in the sequence in which the steel beams will be used on the job! This advantage is significant because storage space is limited at most construction sites in urban areas. This strong value-added service allows Nucor to achieve higher levels of profitability than its competitors. Sales-Marketing-Logistics Integration The rising value of logistics as a strategic marketing weapon has fostered the integration of the sales, marketing, and logistics functions of many business marketers. In progressive firms, unified teams of sales, production, logistics, information systems, and marketing personnel develop integrated logistics programs to offer to potential customers. Sales calls are made by teams of specialists from each area, and the teams tailor logistics solutions to customer problems. United Stationers, one of the largest U.S. office products distributors, brings operations and salespeople together to meet with the company’s resellers in an effort to create customer-responsive logistics service. As a result of its efforts, United guarantees customers that orders placed by 7:00 p.m. will be received before noon on the following day. Customers can dial into United’s mainframe computer and place orders electronically. The company considers all of its logistics people to be part of the sales function. Some firms have taken the integration even further. Baxter Healthcare warehouse workers team up with warehouse personnel at the hospitals that Baxter serves. During visits to the customer warehouse, the Baxter warehouser evaluates the operation, looking for ways to improve packing so shipments are easier to unload and unpack. As a result, Baxter warehousers have become salespeople. Just-in-Time Systems To serve a customer, business marketers must be prepared to deliver their products frequently and with precise timing. The reason is the widespread adoption by manufacturing firms, like Honda of America, of the just-in-time ( JIT) inventory principle. Under this principle, suppliers carefully coordinate deliveries with the manufacturer’s 30 James Stock, Thomas W. Speh, and Herbert Shear, “Many Happy (Product) Returns,” Harvard Business Review 80 ( July 2002): p. 14. 344 Part IV Formulating Business Marketing Strategy production schedule—often delivering products just hours before they are used. The objective of a JIT system is to eliminate waste of all kinds from the production process by requiring the delivery of the specified product at the precise time, and in the exact quantity needed. Importantly, the quality must be perfect—there is no opportunity to inspect products in the JIT process. Because JIT attempts to relate purchases to production requirements, the typical order size shrinks, and more frequent deliveries are required. Increased delivery frequency presents a challenge to the business marketing production and logistics system. However, business marketers will have to meet this challenge, as many competitors now compete on the basis of inventory turns and speed to market.31 Just-in-Time Relationship A significant effect of JIT purchasing has been to drastically reduce the number of suppliers manufacturers use. Suppliers who are able to meet customers’ JIT requirements find their share of business growing.32 Meeting JIT requirements often represents a marketing edge and may mean survival for some suppliers. The relationship between JIT suppliers and manufacturers is unique and includes operational linkages that unite the buyer and seller. As a result, suppliers find that the relationships are longer lasting and usually formalized with a written contract that may span up to 5 years. Elements of a Logistical System Table 13.1 presents the controllable variables of a logistical system. Almost no decision on a particular logistical activity can be made without evaluating its effect on other areas. The system of warehouse facilities, inventory commitments, order-processing methods, and transportation linkages determines the supplier’s ability to provide timely product availability to customers. As a result of poor supplier performance, customers may have to bear the extra cost of higher inventories, institute expensive priority-order-expediting systems, develop secondary supply sources, or, worst of all, turn to another supplier. Total-Cost Approach In the management of logistical activities, two performance variables must be considered: (1) total distribution costs and (2) the level of logistical service provided to customers. The logistical system must be designed and administered to achieve that combination of cost and service levels that yields maximum profits. Logistical costs vary widely for business marketers, depending on the nature of the product and on the importance of logistical service to the buyer. Logistical costs can consume 16 to 36 percent of each sales dollar at the manufacturing level, and logistical activities can consume more than 40 percent of total assets. Thus, logistics can have a significant effect on corporate profitability. How, then, can the marketer manage logistical costs? The total-cost, or trade-off, approach to logistical management guarantees to minimize total logistical costs in the firm and within the channel. The assumption is that costs of individual logistical activities are interactive; that is, a decision about one logistical variable affects all or some of the others. Management is thus concerned 31 Andrew Tanzer, “Warehouses That Fly,” Forbes, October 18, 1999, p. 121. 32 Peter Bradley, “Just-in-Time Works, but. . . .” Purchasing 118 (September 1995): p. 36. Chapter 13 TABLE 13.1 Supply Chain Management 345 CONTROLLABLE ELEMENTS IN A LOGISTICS SYSTEM Elements Key Aspects Customer service The “product” of logistics activities, customer service relates to the effectiveness in creating time and place utility. The level of customer service provided by the supplier has a direct impact on total cost, market share, and profitability. Order processing Order processing triggers the logistics process and directs activities necessary to deliver products to customers. Speed and accuracy of order processing affect costs and customer service levels. Logistics communication Information exchanged in the distribution process guides the activities of the system. It is the vital link between the firm’s logistics system and its customers. Transportation The physical movement of products from source of supply through production to customers is the most significant cost area in logistics, and it involves selecting modes and specific carriers as well as routing. Warehousing Providing storage space serves as a buffer between production and use. Warehousing may be used to enhance service and to lower transportation costs. Inventory control Inventory is used to make products available to customers and to ensure the correct mix of products is at the proper location at the right time. Packaging The role of packaging is to provide protection to the product, to maintain product identity throughout the logistics process, and to create effective product density. Materials handling Materials handling increases the speed of, and reduces the cost of, picking orders in the warehouse and moving products between storage and the transportation carriers. It is a cost-generating activity that must be controlled. Production planning Utilized in conjunction with logistics planning, production planning ensures that products are available for inventory in the correct assortment and quantity. Plant and warehouse location Strategic placement of plants and warehouses increases customer service and reduces the cost of transportation. SOURCE: Adapted from James R. Stock and Douglas M. Lambert, Strategic Logistics Management, 5th ed. (Homewood, IL: McGraw-Hill, 2000). with the efficiency of the entire system rather than with minimizing the cost of any single logistical activity. The interactions among logistical activities (that is, transportation, inventory, warehousing) are described as cost trade-offs because a cost increase in one activity is traded for a large cost decrease in another activity, the net result being an overall cost reduction. 346 Part IV Formulating Business Marketing Strategy Calculating Logistics Costs Activity-Based Costing The activity-based costing (ABC) technique is used to precisely measure the costs of performing specific activities and then trace those costs to the products, customers, and channels that consumed the activities.33 This is a powerful tool in managing the logistics operations of a supply chain. ABC provides a mechanism to trace the cost of performing logistics services for the customers that use these services, making it easier to assess the appropriate level of customer service to offer. Firms using ABC analysis can obtain more accurate information about how a particular customer or a specific product contributes to overall profitability.34 Total Cost of Ownership Total cost of ownership (TCO) determines the total costs of acquiring and then using a given item from a particular supplier (see Chapter 2). The approach identifies costs—often buried in overhead or general expenses—that relate to the costs of holding inventory, poor quality, and delivery failure.35 A buyer using TCO explicitly considers the costs that the supplier’s logistics system either added to, or eliminated from, the purchase price and would take a long-term perspective in evaluating cost.36 Thus, a supplier particularly efficient at logistics might be able to reduce the buyer’s inventory costs and the buyer’s expenses of inspecting inbound merchandise. As a result, the total cost of ownership from that supplier would be lower than the cost from other suppliers that were not able to rapidly deliver undamaged products. Increasing acceptance of the TCO approach will cause logistics efficiency to become an even more critical element of a business marketer’s strategy. Business-to-Business Logistical Service Many studies have shown that logistics service is often just as important as product quality as a measure of supplier performance. In many industries, a quality product at a competitive price is a given, so customer service is the key differentiator among competitors. In one industry, for example, purchasing agents begin the buying process by calling suppliers with the best delivery service to see whether they are willing to negotiate prices. Because it is so important to customers, reliable logistics service can lead to higher market share and higher profits. A study by Bain and Company showed that companies with superior logistics service grow 8 percent faster, collect a 7 percent price premium, and are 12 times as profitable as firms with inferior service levels.37 33 Bernard J. LaLonde and Terrance L. Pohlen, “Issues in Supply Chain Costing,” International Journal of Logistics Management 7 (1, 1996): p. 3. 34 Thomas A. Foster, “Time to Learn the ABCs of Logistics,” Logistics (February 1999): p. 67. 35 Lisa Ellram, “Activity-Based Costing and Total Cost of Ownership: A Critical Linkage,” Journal of Cost Management 8 (Winter 1995): p. 22. 36 Bruce Ferrin and Richard E. Plank, “Total Cost of Ownership Models: An Exploratory Study,” Journal of Supply Chain Management 38 (Summer 2002): p. 18. 37 Mary Collins Holcomb, “Customer Service Measurement: A Methodology for Increasing Customer Value through Utilization of the Taguchi Strategy,” Journal of Business Logistics 15 (1, 1994): p. 29. Chapter 13 TABLE 13.2 Supply Chain Management 347 COMMON ELEMENTS OF LOGISTICS SERVICE Elements Description Delivery time The time from the creation of an order to the fulfillment and delivery of that order encompasses both orderprocessing time and delivery or transportation time. Delivery reliability The most frequently used measure of logistics service, delivery reliability focuses on the capability of having products available to meet customer demand. Order accuracy The degree to which items received conform to the specification of the order. The key dimension is the incidence of orders shipped complete and without error. Information access The firm’s ability to respond to inquiries about order status and product availability. Damage A measure of the physical conditions of the product when received by the buyer. Ease of doing business A range of factors, including the ease with which orders, returns, credits, billing, and adjustments are handled. Value-added services Such features as packaging, which facilitates customer handling, or other services such as prepricing and drop shipments. SOURCE: Reprinted with permission from Jonathon L. S. Byrnes, William C. Copacino, and Peter Metz, “Forge Service into a Weapon with Logistics,” Transportation & Distribution, Presidential Issue 28 (September 1987): p. 46. These facts, together with the extensive spread of just-in-time manufacturing, make it clear that logistical service is important to organizational buyers. Logistical service relates to the availability and delivery of products to the customer. It comprises the series of sales-satisfying activities that begin when the customer places the order and that end when the product is delivered. Responsive logistical service satisfies customers and creates the opportunity for closer and more profitable buyerseller relationships.38 Logistical service includes whatever aspects of performance are important to the business customer (Table 13.2). These service elements range from delivery time to value-added services, and each of these elements can affect production processes, final product output, costs, or all three. Logistics Service Impacts on the Customer Supplier logistical service translates into product availability. For a manufacturer to produce or for a distributor to resell, industrial products must be available at the right time, at the right place, and in usable condition. The longer the supplier’s delivery time, the less available the product; the more inconsistent the delivery time, the less available the product. For example, a reduction in the supplier’s delivery time permits a buyer to hold less inventory because needs can be met rapidly. The customer 38 Arun Sharma, Dhruv Grewal, and Michael Levy, “The Customer Satisfaction/Logistics Interface,” Journal of Business Logistics 16 (2, 1995): p. 1. 348 Part IV Formulating Business Marketing Strategy reduces the risk that the production process will be interrupted. Consistent delivery enables the buyer to program more effectively—or routinize—the purchasing process, thus lowering buyer costs. Consistent delivery-cycle performance allows buyers to cut their level of buffer or safety stock, thereby reducing inventory cost. However, for many business products, such as those that are low in unit value and relatively standardized, the overriding concern is not inventory cost but simply having the products. A malfunctioning $0.95 bearing could shut down a whole production line. Determining the Level of Service Buyers often rank logistics service right behind “quality” as a criterion for selecting a vendor. However, not all products or all customers require the same level of logistical service. Many made-to-order products—such as heavy machinery—have relatively low logistical service requirements. Others, such as replacement parts, components, and subassemblies, require extremely demanding logistical performance. Similarly, customers may be more or less responsive to varying levels of logistical service. Profitable Levels of Service In developing a logistical service strategy, business marketing strategists should assess the profit impact of the service options that they provide to customers. In nearly all industries, firms provide numerous supply chain services such as next-day delivery, customized handling, and specialized labeling. However, few companies actually trace the true costs of specialized services and the resulting effect on customer profitability (see Chapter 4). To combat this unhealthy situation, some companies are now using cost-to-serve analytics to address the problem—among them are Dow Chemical, Eastman Chemical, and Georgia-Pacific (GP). GP used total-delivered-cost analysis to improve the performance of a major customer account.39 By incorporating cost-to-serve data into the calculation of gross margin, GP’s supply chain team determined that the costs to provide this customer with expedited transportation and distribution services were significantly reducing the account’s profitability. In a top-to-top meeting with the customer, GP used the data to expose the root causes of the high costs and poor service, which included last-minute, uncoordinated promotional planning and purchasing across the customer’s major business units and the customer’s unwillingness to share inventory levels and positioning. Customers, once confronted with the data, are often willing to collaborate on ways to improve service, reduce costs, and restore profitability. To recap, service levels are developed by assessing customer service requirements. The sales and cost of various service levels are analyzed to find the service level generating the highest profits. The needs of various customer segments dictate various logistical system configurations. For example, when logistical service is critical, industrial distributors can provide the vital product availability, whereas customers with less rigorous service demands can be served from factory inventories. Logistics Impacts on Other Supply Chain Participants A supplier’s logistical system directly affects a distributor’s ability to control cost and service to end users. Delivery time influences not only the customer’s inventory 39 Remko Van Hoek, “When Good Customers Are Bad,” Harvard Business Review 83 (September 2005): p. 19. Chapter 13 Supply Chain Management 349 requirements but also the operations of channel members. If a supplier provides erratic delivery service to distributors, the distributor is forced to carry higher inventory in order to provide a satisfactory level of product availability to end users. Inefficient logistics service to the distributors either increases distributor costs (larger inventories) or creates shortages of the supplier’s products at the distributor level. Neither result is good. In the first instance, distributor loyalty and marketing efforts will suffer; in the second, end users will eventually change suppliers. When Palm, Inc., developed the Palm Pilot, the firm created such an effective logistics system that its distributors in Latin America were able to offer the same level of aftersales service available in the United States, allowing Palm to reach sales exceeding $250 million in Latin America in a short time frame.40 In some industries, distributors are expanding their role in the logistics process, which makes them even more valuable to their suppliers and customers. In the chemical industry, for example, the role of distributors is completely transforming as they offer logistics solutions—JIT delivery, repackaging, inventory management—to their customers.41 The logistics expertise distributors provide enables their vendors (manufacturers) to focus on their own core competencies of production and marketing. Business-to-Business Logistical Management The elements of logistics strategy are part of a system, and as such, each affects every other element. The proper focus is the total-cost view. Although this section treats the decisions on facilities, transportation, and inventory separately, these areas are so intertwined that decisions in one area influence the others. Logistical Facilities The strategic development of a warehouse provides the business marketer with the opportunity to increase the level of delivery service to buyers, reduce transportation costs, or both. Business firms that distribute repair, maintenance, and operating supplies often find that the only way to achieve desired levels of delivery service is to locate warehouses in key markets. The warehouse circumvents the need for premium transportation (air freight) and costly order processing by keeping products readily available in local markets. Serving Other Supply Chain Members The nature of the business-to-business (B2B) supply chain affects the warehousing requirements of a supplier. Manufacturers’ representatives do not hold inventory, but distributors do. When manufacturers’ reps are used, the supplier often requires a significant number of strategically located warehouses. On the other hand, a supply chain using distributors offsets the need for warehousing. Obviously, local warehousing by the distributor is a real service to the supplier. A few well-located supplier warehouses may be all that is required to service the distributors effectively. 40 Toby Gooley, “Service Stars,” Logistics (June 1999): p. 37. 41 Daniel J. McConville, “More Work for Chemical Distributors,” Distribution 95 (August 1996): p. 63. 350 Part IV Formulating Business Marketing Strategy Outsourcing the Warehousing Function Operating costs, service levels, and investment requirements are essential considerations regarding the type of warehouse to use. The business firm may either operate its own warehouses or turn them over to a “third party”—a company that specializes in performing warehousing services. The advantages of third-party warehousing are flexibility, reduced assets, and professional management—the firm can increase or decrease its use of space in a given market, move into or out of any market quickly, and enjoy an operation managed by specialists. Third-party warehousing may sometimes supplement or replace distributors in a market. Many third-party warehouses provide a variety of logistical services for their clients, including packaging, labeling, order processing, and some light assembly. Saddle Creek Corporation, a third-party warehouse company based in Lakeland, Florida, maintains warehouse facilities in a number of major markets. Clients can position inventories in all these markets while dealing with only one firm. Also, Saddle Creek can link its computer with the suppliers’ computers to facilitate order processing and inventory updating. The Saddle Creek warehouse also repackages products to the end-user’s order, label, and arrange for local delivery. A business marketer can ship standard products in bulk to the Saddle Creek warehouse—gaining transportation economies—and still enjoy excellent customer delivery service. The public or contract warehouse is a feasible alternative to the distributor channel when the sales function can be economically executed either with a direct sales force or with reps. Transportation Transportation is usually the largest single logistical expense, and with continually rising fuel costs, its importance will probably increase. Typically, the transportation decision involves evaluating and selecting both a mode of transportation and the individual carrier(s) that will ensure the best performance at the lowest cost. Mode refers to the type of carrier—rail, truck, water, air, or some combination of the four. Individual carriers are evaluated on rates and delivery performance.42 The supply chain view is important in selecting individual carriers. Carriers become an integral part of the supply chain, and close relationships are important. One study found evidence that carriers’ operating performance improved when they were more involved in the relationship between buyer and seller.43 By further integrating carriers into the supply chain, the entire supply chain can improve its competitive position. In this section we consider (1) the role of transportation in industrial supply chains and (2) the criteria for evaluating transportation options. Transportation and Logistical Service A business marketer must be able to effectively move finished inventory between facilities, to channel intermediaries, and to customers. The transportation system is the link that binds the logistical network together and ultimately results in timely delivery of products. Efficient warehousing does not enhance customer service levels if transportation is inconsistent or inadequate. 42 For example, see James C. Johnson, Donald F. Wood, Danile L. Warlow, and Paul R. Murphy, Contemporary Logistics, 7th ed. (Upper Saddle River, NJ: Prentice Hall, 1998). 43 Julie Gentry, “The Role of Carriers in Buyer-Supplier Strategic Partnerships: A Supply Chain Management Approach,” Journal of Business Logistics 17 (2, 1996): p. 52. Chapter 13 Supply Chain Management 351 Effective transportation service may be used in combination with warehouse facilities and inventory levels to generate the required customer service level, or it may be used in place of them. Inventory maintained in a variety of market-positioned warehouses can be consigned to one centralized warehouse when rapid transportation services exist to deliver products from the central location to business customers. Xerox is one company that uses premium airfreight service to offset the need for high inventories and extensive warehouse locations. The decision on transportation modes and particular carriers depends on the cost trade-offs and service capabilities of each. It is interesting that in the age of next-day delivery and express airfreight services, barges that weave their way through a maze of rivers, lakes, and channels are thriving.44 A barge trip that takes 17 hours would take a train 4 hours and a truck 90 minutes for a similar trip. Although very slow (averaging 15 miles per hour), the barge offers huge cost advantages compared with truck and rail. For products like limestone, coal, farm products, and petroleum, the slow and unglamorous barge is an effective logistics tool. Transportation Performance Criteria Cost of service is the variable cost of moving products from origin to destination, including any terminal or accessory charges.
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